Shorts Are Piling Into These Stocks. Should You Be Worried?

Do short-sellers have these stocks pegged? You be the judge!

Feb 3, 2014 at 6:35PM

The best thing about the stock market is that you can make money in either direction. Historically, stock indexes tend to trend upward over the long term. But when you look at individual stocks, you'll find plenty that lose money over the long haul. According to hedge fund institution Blackstar Funds, between 1983 and 2006, even with dividends included, 64% of stocks underperformed the Russell 3000, a broad-scope-market index.

A large influx of short-sellers shouldn't be a condemning factor for any company, but it could be a red flag indicating that something is off. Let's look at three companies that have seen a rapid increase in the number of shares sold short and see whether traders are blowing smoke or their worry has some merit.

Company

Short Increase Dec. 31 to Jan. 15

Short Shares as a % of Float

FedEx (NYSE:FDX)

290.6%

5.1%

J.C. Penney (NYSE:JCP)

25.9%

36.1%

Best Buy (NYSE:BBY)

27.9%

9.7%

Source: The Wall Street Journal.

Relax. It's FedEx!
The past two months have certainly been a mixed bag for one of the world's largest logistics companies, FedEx.

In December, the company announced relatively impressive second-quarter earnings results that showed a 13% increase in earnings per share on a 3% increase in revenue to $11.4 billion. However, this favorable year-over-year comparison owes much to the $0.11 that Hurricane Sandy shaved off last year's EPS. Considerably more impressive was that FedEx upped its full-year forecast EPS growth forecast from 7%-13% to 8%-14%. It may not sound like much, but for an enormous company like FedEx, that should translate into upside movement in its share price.

Conversely, though, December was a weak month for many retailers, which points to growing speculation that the tapering of the Federal Reserve's quantitative easing could further reduce consumer spending and negatively impact FedEx's shipping business. We already saw FedEx take the initiative in December to announce a boost to FedEx Ground rates for 2014, signaling that it may need to turn to price increases to bump organic growth higher.  

Who's right? I'm considerably more inclined to side with the optimists on FedEx despite the subpar holiday shopping season. FedEx has incredible pricing power, and it's not as if consumers have a whole lot of choices when it comes to shipping a package. Most consumers consider going to the post office a chore, and FedEx has the reputation of reliability and profitability on its side.

I do admit that I wish FedEx would focus less on share buybacks to mask single-digit top-line growth and instead implement a more sizable increase to its quarterly payout -- it raised its dividend by $0.01 per quarter in June yet still yields a paltry 0.5%. But if this is my only real gripe, then shareholders can probably just relax and allow the company's brand presence to drive traffic into its stores.

An exercise in destroying shareholder value
Oh, look: J.C. Penney's short interest rose again. Who else is shocked?!

J.C. Penney has been an absolute disaster for the better part of two years; the department store chain's brand identity is lost, its core customer is shopping elsewhere, and the business is hemorrhaging cash with no clearly defined time frame for returning to profitability.

Earlier this month, J.C. Penney announced that it would close 33 underperforming locations in an effort to save $65 million annually. Even more drastically, though, just this past week Penney announced an aggressive poison pill plan amendment designed to keep prospective activist investors at or under 4.9% ownership. Perhaps the only saving grace for J.C. Penney had been the thought of a private-equity takeover or a larger investor pretty much sweeping in and cleaning house. With that idea basically off the table, the company has effectively closed off the final avenue of shareholder appreciation for investors.

What's left is a disorganized mess. CEO Myron Ullman hasn't really implemented new strategies, instead returning to the old ones he used when things were just "bad" instead of really, really bad under Ron Johnson. While that will definitely narrow company losses and help improve some favorable same-store sales comparisons, it's not likely to get customers back in the door or excite new consumers to shop at Penney's.

Beyond cost-cutting efforts, J.C. Penney has no distinct attributes that should entice consumers or investors. Although it has arranged fresh funding, the company still looks to be on a slippery slope toward a seemingly inevitable disaster. It's a company that short-sellers have every right to be skeptic about.

Best Buy or impending failure?
Big-box electronics retailer Best Buy has been a tough cookie to figure out. The company's restructuring plan, which includes closing larger underperforming stores and opening smaller, mobile-focused stores, as well as incentivizing its sales associates for sales made, appears to be working well in terms of driving customer traffic into stores and stymieing the "showroom" effect.

Yet Best Buy's holiday sales (a nine-week period that encompasses the holidays) dipped 0.9% in the United States, which was a marked improvement from last year but still points to a weak retail environment and a shrinking top-line number. Given that Best Buy had tripled from its lows with stagnant revenue growth, it's no wonder the stock got clobbered.

The real question is where Best Buy goes from here. Despite the noted top-line weakness and growing competition from online retailers, I suspect there could be more upside potential left in Best Buy shares than downside at the moment. In other words, I'm not buying into the "Best Buy is going to fail" hype.

The primary reason Best Buy can still thrive is its growing online presence -- same-store comps for online sales grew 23.5% year over year -- as well as the fact that it's becoming more nimble by going smaller. Mobile products may not always deliver the best margins, but the primary goal of this move is to drive traffic into its stores. If Best Buy is successful in that respect, and can improve loyalty through the use of a Best Buy card, it should be able to encourage the sale of discretionary items, which will eventually drive top-line growth.

Best Buy is also a cash-flow-generating machine. Unless there's a serious decline in cash flow generation from this point in time, I see no reason for shareholders not to believe the Best Buy turnaround story.

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Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

The Motley Fool recommends FedEx. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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