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

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

Mar 10, 2014 at 5:25PM

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 isn't 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 if traders are blowing smoke or their worries have merit.

Company

Short Increase Jan. 31 to Feb. 14

Short Shares as a % of Float

WellPoint (NYSE:ANTM)

97%

4%

Halliburton (NYSE:HAL)

38.5%

1.9%

Dow Chemical (NYSE:DOW)

23.3%

3.3%

Source: The Wall Street Journal.

Mixed reaction
The implementation of Obamacare has divided investors on the subject of how health insurers will perform. On one hand, investors expect an increase in membership to bode well for insurers, adding to their bottom lines. However, a number of skeptics also believe that an Obamacare enrollment shortfall and an inability to meet young-adult enrollment targets will lead insurers to take potentially hefty losses.

Some of WellPoint's larger national peers have struggled with Obamacare's individual marketplace thus far, with CIGNA (NYSE:CI) and Aetna (NYSE:AET) only gaining 20,000 and 200,000 members, respectively. Both CIGNA and Aetna are also losing money on their Obamacare-enrolled members. But investors should keep in mind that these two national insurers also pulled out of quite a few states before the health exchanges went live on Oct. 1, and they make a good portion of their money insuring employees of large businesses -- not necessarily on the individual marketplace.

For WellPoint, its reality lies somewhere in between. WellPoint has been able to sign up 400,000 members through January and is benefiting from its 2012 purchase of Amerigroup, which targeted government-sponsored Medicaid enrollees. The good news is that WellPoint is actually making money on its Obamacare plans as of now, but the catch-22 to that is that it's also having to leave a number of potential members uninsured because approximately half of all U.S. states chose not to take federal money and expand their Medicaid programs.

At just 10 times its forward earnings, I would suggest that the risk-versus-reward for WellPoint still favors optimists. A lot is going to depend on the final make-up of Obamacare's enrollment figures which we should know a month from now, but WellPoint appears to be the clear standout among the insurance sector.

Digging deep
Crude prices may have seen a nice rebound over the past couple of months, but you'd have a hard time realizing it by looking at most oil drillers and refiners, whose share prices are plodding along. The concern is that drilling demand in the U.S., especially in the deepwater segment, may be plateauing in the interim, which has the potential to cause a chain of capital-expenditure cuts down the line. That would bode poorly for oil drilling service contractors like Halliburton that rely on robust demand to keep the cogs turning.

But in order to understand Halliburton you have to be willing to look at the health of the global market. According to its most recent quarterly results, Halliburton was able to deliver 17% revenue growth in the Eastern Hemisphere and projected low double-digit revenue growth from this region again in 2014. Despite the slight slowdown in forecast year-over-year growth, Halliburton is forecasting that Eastern Hemisphere margins will improve, potentially boosting overall profitability. Its forecast for the North American markets was a more subdued 200 basis point improvement in margins, which is expected to come from tight cost controls and more drilling activity in the Gulf of Mexico.

In other words, even with deepwater drillers struggling and a number of land-based drillers scaling back on their capex in order to conserve cash flow, Halliburton was still able to deliver record quarterly revenue. This speaks to the diversity of the business and the proactive steps management takes to stay ahead in today's marketplace.

With the company boosting its dividend twice in 2013 and repurchasing 10% of its outstanding shares, it's clear that Halliburton's management is focused on improving shareholder value. That seems like a good recipe to me for short-sellers to keep their distance.

Volatile chemicals?
The story is actually very similar for global chemicals, plastics, and agrosciences company Dow Chemical, which is slowly building quite the following of short-sellers after rallying roughly 65% off its 52-week lows.

As with most chemical product suppliers, global growth tends to determine its overall direction. Because Dow Chemical has been moving higher at a steady pace, the thinking here among investors is that the global economy is in great shape and all of Dow's business segments should benefit. Thus far that way of thinking has been correct.

In Dow Chemical's fourth quarter, the company reported sales growth across all but one of its operating segments, including 5% growth in performance plastics and a whopping 13% increase in agricultural sciences. These big gains point to a number of emerging market growth opportunities in Latin America as well as Asia.

However, Dow's forward guidance and commentary also left a lot to be desired by shareholders. Admittedly, Dow Chemical isn't too expensive at roughly 14 times forward earnings, but its growth rate of 3%-4% is less than impressive, especially when management is so cautious about the company's current prospects. In the words of management, "While we are seeing positive trends in major economies as we enter 2014, global growth remains tentative, continuing to drive business uncertainty." 

This uncertainty is prompting Dow Chemical to boost its dividend by 15% and expand its share repurchasing agreement to $4.5 billion. While great news for shareholders, this buyback could also mask a lack of top-line growth.

Ultimately, Dow is tough to gauge. On one side we have a 3% yield and a consistently growing business model packed with share buybacks that should keep short-sellers at bay. But there's plenty of reason to be skeptical of its global growth rate and use of capital to buy back stock rather than reinvest in the business. All told, I'd rather stick to the sidelines than make a bet either way on Dow Chemical at the moment.

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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 owns shares of, and recommends WellPoint. It also recommends Halliburton. 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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