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

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

Mar 31, 2014 at 5:03PM

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 rapid increases in the number of shares sold short and see whether traders are blowing smoke or if their worries have merit.

Company

Short Increase Feb. 28 to March 14

Short Shares as a % of Float

Juniper Networks (NYSE:JNPR)

107.1%

8.6%

Home Depot (NYSE:HD)

90.1%

1.5%

Teradyne (NYSE:TER)

57.8%

26.3%

Source: The Wall Street Journal.

Monkey see, monkey do?
Juniper Networks may be a fraction of the size of larger rival Cisco Systems (NASDAQ:CSCO), but despite its faster growth rate the networking equipment maker is being dragged down by its larger foe due to what I'd call "guilt by association."

I've supported Cisco in the past as a solid investment, and I still hold that position, but it's also not without a number of near-term issues. Cisco has been laying off workers in order to cut costs, and it has shifted its entire product line to prepare for next-generation cloud and data center networking devices. This extra money spent on research and development and the product focus shift was costly, and it has weighed heavily on Cisco's bottom line in recent years.

The same worries have surrounded Juniper. Pessimists anticipate that higher research costs and erratic demand will pressure its margins and send Juniper lower in a fashion akin to Cisco Systems. While I no longer believe Juniper is the screaming buy it once was, I still wouldn't dare bet against it -- especially after the company's stellar fourth-quarter results.

Juniper delivered a 12% year-over-year increase in revenue, saw its GAAP operating margin improve 310 basis points to 15.3%, and delivered an adjusted earnings-per-share profit of $0.43, up 30% from the year-ago quarter. I believe that being smaller and having its fingers in fewer segments has allowed Juniper to make a more seamless transition into the cloud. What this could mean for Juniper is a considerably faster growth rate than Cisco for perhaps the next couple of years.

Juniper is also likely to benefit from big spending in the domestic telecommunication sector. With every major telecom company announcing a purchase of some form or another over the past two years, the battle for 4G-LTE supremacy is just heating up. As these companies spend billions to beef up their infrastructure, Juniper stands ready to benefit once those funds trickle down the pipeline.

With the stock valued at roughly 14 times forward earnings, I'd suggest short-sellers pick their battles elsewhere.

Hitting both markets
Since the market bottomed in 2009, the housing sector has been a source of triumph for many investors, with prices rebounding and low interest rates spurring first-time homebuyers and investors to take the plunge. However, with the Federal Open Market Committee paring back its monthly economic stimulus, skeptics suspect that lending rates will rise (due to fewer long-term U.S. Treasuries being purchased) which, in turn, could negatively impact housing and housing supply stores such as Home Depot.

While I've personally been no fan of the housing industry for this exact reason, I still have a very positive outlook for Home Depot.

To start, Home Depot hits both ends of the consumer and commercial market. On the consumer side of the business, if fewer people are buying new homes or moving, Home Depot has an opportunity to make bank by being their one-stop shop for home remodeling. On the other hand, if low lending rates continue to fuel home purchases then it'll remain a regular stop for contractors. By hitting both markets in nearly any economic environment Home Depot remains in great shape.

Another thing to keep in mind is that the barrier to entry in the do-it-yourself space is pretty high. Although you'll see warehouse chains such as Wal-Mart try to compete with Home Depot on select home-based items, with the exception of Lowe's there just aren't many genuine threats. With that in mind, Home Depot understands it has the pricing and branding power to command foot traffic for its advantage.

Finally, an often overlooked factor is that Home Depot has also delivered incredible dividend growth, from just $0.04 per quarter in 2000 to $0.47 in its latest quarter. In addition, over the past decade Home Depot stock buybacks have reduced its outstanding shares from 2.2 billion to approximately 1.4 billion. Its dividend is putting significantly more money in shareholders' pockets, while stock buybacks are helping to improve EPS and make the company appear even cheaper. It's not a business I'd suggest short-sellers latch onto.

Getting a bit chippy
For automatic test equipment, or ATE, manufacturer Teradyne what goes up just keeps going up, and up, and up some more!

The company, with makes ATEs for semiconductors, wireless products, and complex electronics systems, has been in a steady uptrend for five years as a wide swath of consumer products have rebounded and orders for semiconductors have generally improved. Skeptics are merely counting on the natural cyclicality of the industry to bring Teradyne back to earth. Considering that Wall Street's EPS estimates were lowered over the past 90 days given fourth-quarter seasonal weakness, I can see how that could be a possibility. 

On the flip side, there are a number of reasons why Teradyne could head even higher. For one, soaring mobile-device demand means an increased need for testing equipment of the kind offered by Teradyne. In addition, while still in its general infancy, the need for storage and data equipment for the cloud should drive growth for ATE manufacturers such as Teradyne.

Yes, at some point Teradyne will run into a cyclical brick wall -- it's simply the nature of the semiconductor sector. However, Teradyne is well prepared with $742 million in net cash that it can fall back on if things get really bad. With full-year margins higher than they've been in a decade, I would not place bets against Teradyne 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 recommends Cisco Systems and Home Depot. 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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