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

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

Feb 10, 2014 at 4:33PM

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 worries have some merit.

Company

Short Increase Dec. 31 to Jan. 15

Short Shares as a % of Float

UnitedHealth Group (NYSE:UNH)

47.9%

2.3%

Family Dollar Stores (NYSE:FDO)

56.7%

7.1%

Ingram Micro (NYSE:IM)

62.8%

0.8%

Source: The Wall Street Journal

Clobbered by Obamacare? Not quite
You might say the impact of Obamacare on businesses' profits can be hit or miss depending upon the industry, and sometimes even within the same sector. UnitedHealth Group, the nation's largest health-insurer, has faced increasing scrutiny from investors lately, with Obamacare enrollment only touching 3 million as of late last month and running about 1 million enrollments behind schedule, according to original signup estimates by the Department of Health and Human Services. If UnitedHealth Group doesn't see strong enrollments, or even if its peers fail to add a significant number of new members, premiums could rise dramatically in 2015 and hurt the entire sector.

We received confirmation on Friday of the early indications that Obamacare is giving insurers indigestion. National insurer CIGNA (NYSE:CI) reported a steep incline in medical costs, especially with regard to its Medicare Advantage plans -- which, to remind you, make up about one-quarter of UnitedHealth Group's total revenue. CIGNA's full-year guidance, inclusive of an expected decline in Medicare reimbursement rates from the Centers for Medicare and Medicaid Services, was for $6.80-$7.20 in EPS, well below the Street's estimate of $7.32. 

I'd certainly say that CIGNA's cautionary tale as it relates to Medicare Advantage certainly merits more skepticism in UnitedHealth's share price. But I wouldn't close yourself off to the fact that UnitedHealth's diverse business does afford it more opportunity than many of its peers, so this news isn't as disastrous as it might appear on the surface.

Also bear in mind that little of UnitedHealth's revenue is dependent on Obamacare enrollments, and glitches at the beginning of any major health care reform are the norm. In other words, most shareholders should give the company the benefit of doubt, at least for a few quarters. At 12 times forward earnings, UnitedHealth isn't particularly expensive, but the upside catalysts are limited until more is known about how Obamacare will affect premiums in the long run.

Warning: Objects in mirror are larger than they appear
Without question, this is a difficult sales-growth environment for just about any retailer, yet a select few are thriving. One company where sentiment is clearly mixed is deep-discount retailer Family Dollar Stores, which should be thriving in an environment where consumers are holstering their cash and seeking hefty discounts -- but perception and reality are proving to be two different things.

In January, Family Dollar reported its first-quarter results, which included a 3.2% increase in net sales to $2.5 billion as its consumable sales (i.e., refrigerated and frozen food, health aids, and tobacco) rose just shy of 5% during the quarter. This might give off the appearance of healthy growth, but sales only rose because the company opened 126 new stores. When you back those locations out of the equation, Family Dollar Stores' same-store sales actually fell 2.8% and points to a decline in consumer foot traffic and discretionary spending.

The real concern that shareholders should have here is that Dollar General (NYSE:DG) is running circles around Family Dollar. With a broad selection of food and increased tobacco sales, which may benefit even more with the announcement that CVS Caremark will stop carrying tobacco products in October, it's conceivable that Dollar General will continue to outperform Family Dollar in nearly every statistical category.

I would suggest allowing short-sellers to have their way with Family Dollar until it figures out how to improve organic traffic and closes the gap dramatically between it and Dollar General.

Ingram Micro: macro profits?
One of the most short-sold business sectors since the recession is anything having to do with computer wholesale. The wholesale-computer-parts business runs on razor-thin margins, is prone to cyclicality, and often sees a downtrend in pricing power as newer technologies are introduced. It's one reason why a company like Ingram Micro is often a bull's-eye for short-sellers.

But I would strongly suggest that short-sellers reconsider their pessimism based on two recent strategic moves by Ingram Micro.

First, Ingram Micro purchased Brightpoint for $840 million in July 2012 to expand its mobile logistics business. "What exactly is mobile logistics?" you might be wondering? Well, think about all of those mobile phones that need to be preprogrammed with specific software or need to be refurbished due to physical or software issues. Ingram Micro takes care of that, and its purchase of Brightpoint only expanded the number of vendor relationships under its belt. 

The other move came just a little more than two weeks ago when Ingram announced that it would be catering to the 3-D printing market from a logistics perspective. I'm not going to lie: I'm a bit leery of 3-D printing company valuations and think the technology could be a few years out from realizing even one-tenth of its potential, but I nonetheless see this as a key move for Ingram to secure high-margin logistics revenue for next-generation tech products.

With Ingram valued at less than 10 times forward earnings, short-sellers could be playing with fire.

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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 UnitedHealth Group. 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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