The Nasdaq's 3 Most Hated Stocks

Since hitting highs not seen in practically 14 years, the technology- and biotechnology-heavy Nasdaq Composite has been throttled, falling more than 5% on a trailing basis from the high point reached in early March.

Comparatively speaking, this latest correction is nothing more than a blip for an index that has soared more than 200% since the recession. The Nasdaq Composite has been a direct beneficiary of record-low lending rates that have allowed fast-growing tech and biotech companies to take on debt in order to expand and further research and development. This innovation surge has led to higher earnings and a return of robust merger and acquisition activity, pumping the index ever higher.

Of course, not everyone is of the same opinion that the Nasdaq, or U.S. markets in general, can head higher.

Skeptics, like myself, point to the winding down of the Federal Reserve's economic stimulus as a primary reason that the markets' run may be done. The Fed has been purchasing mortgage-backed securities and long-term Treasuries for more than a year in order to improve MBS liquidity and push bond prices up (and thus yields lower). With fewer long-term Treasuries being purchased -- and remember, long-term Treasuries help determine mortgage rates -- the chance that interest rates will rise is increasing. A number of other factors are also alarming, such as the precipitous decline in the labor force participation rate and the fact that many companies are masking weak growth prospects behind cost-cutting and share repurchases.

With this in mind, I'm suggesting we do what we do every month: take a deeper dive into the three most hated Nasdaq stocks to see what characteristics, if any, they might share in order to avoid buying into similar companies that have drawn the ire of short-sellers.

Here are the Nasdaq's three most hated stocks:

Company

Short Interest as a % of Outstanding Shares

Myriad Genetics (NASDAQ: MYGN  )

53.5%

Outerwall (NASDAQ: OUTR  )

45.1%

Smith & Wesson (NASDAQ: SWHC  )

39.6%

Source: S&P Capital IQ.

Source: Food and Drug Administration, Wikimedia Commons.

Myriad Genetics
Why are investors shorting Myriad Genetics?

  • Two factors have been fueling the fire for bets against Myriad Genetics since last summer. First, in June the U.S. Supreme Court struck down a handful of Myriad patents that allowed the company to protect its BRACAnalysis gene test from competition. With naturally occurring genes in the body deemed not patentable, a number of would-be competitors entered the market for BRCA 1 and BRCA 2 gene tests, either directly or indirectly, within days. Second, the Centers for Medicare and Medicaid Services in December announced new proposed Medicare reimbursements of just $1,438 for Myriad's BRACAnalysis test, down nearly 50% from the previous reimbursement of $2,795 for the gene test. With BRACAnalysis comprising nearly 70% of Myriad's revenue in its latest quarter, short-sellers are simply counting on tough competition and weaker reimbursements to crush shares.

Is this short interest warranted?

  • With the looming gray cloud of the CMS' decision, some level of skepticism has been deserved. However, now that we know the agency is only going to cut the Medicare reimbursement rate for BRACAnalysis by 22%, to $2,184, shareholders can breathe a bit easier. In addition to this favorable decision, Myriad's top and bottom lines are headed in the right direction with the company handily outpacing Wall Street's expectations in its latest quarter. Myriad is also bringing in a fresh line of rheumatoid arthritis diagnostics with the strategic purchase of privately held Crescendo Bioscience for $270 million, which should be accretive to earnings. All told, Myriad isn't the screaming buy it once was, but short-sellers could continue to get burned here if they aren't careful.

Outerwall
Why are investors shorting Outerwall?

  • You may not recognize the name initially, but Outerwall is the owner of Redbox DVD rental kiosks and Coinstar change kiosks. While its Coinstar machines have performed admirably, delivering 5.9% same-store sales growth in the fourth quarter, the company's Redbox division has had short-selling vultures swarming for some time now. The expectation from pessimists, despite the business remaining profitable up to now, is that streaming movies on your PC, laptop, mobile device, or via your cable or satellite provider will make DVD rental obsolete in coming years. The allure, of course, is that DVD rentals are an incredibly high-margin product if the business is booming, which is why Outerwall has been reluctant to back away.

Is this short interest warranted?

  • In spite of its still impressive cash flow generation of $166 million in 2013, and plans to repurchase up to $350 million in common stock, I believe that betting against Outerwall over the long run is the right move. The primary growth driver here is Coinstar, and that's frankly a scary thought as it only accounted for 13.6% of total revenue in the fourth quarter. Actual Redbox revenue rose just 1.7%, while net revenue per rental was up only 0.4% from the year-ago period. What this tells me is that Redbox is adding new kiosks simply to boost its top line, but it really doesn't have any pricing power since the convenience factor could just as easily sway consumers to stream their movie online or on their home TV. Over the long run I suspect Outerwall has considerably more downside left than upside.
 

Smith & Wesson
Why are investors shorting Smith & Wesson?

  • Firearms manufacturer Smith & Wesson, as well as its peers, have (no pun intended) come under fire from short-sellers in recent years because of the ongoing threat by Congress and the president that tougher gun control laws will be enacted. Tragic scenes, such as those in Fort Hood, Texas, and Newtown, Conn., only serve to drive home the pessimists' point that tougher enforcement is needed which could threaten to drive down sales for gun manufacturers like Smith & Wesson.

Is this short interest warranted?

  • I would say that skepticism is partially deserved, as emotions are a big component as to whether tougher gun control laws are heard before Congress. The midterm election could have big implications on Smith & Wesson, so there's certainly some room for downside if things don't go its way in November. On the other side of the coin, that same fear is leading to impressive sales growth at Smith & Wesson, which recorded a 7% revenue increase in the third quarter amid a 30% rise in year-over-year handgun sales. With its margins rising and the company sporting a minuscule forward P/E of 10, I believe short-sellers can find a number of opportunities more lucrative than this gun maker. 

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 11, 2014, at 2:25 AM, garifolle wrote:

    Short sellers are never strong enough to "crush" a stock down.

    They mainly profit of the downward momentum.

    The over 50% short float of MYGN will soon create a fantastic short squeeze!

  • Report this Comment On April 20, 2014, at 12:28 PM, CatchTwentyTwo wrote:

    I love the short sellers for Outerwall, they have repeatedly provided me opportune times to buy more as Outerwall has repeatedly beat expectations.

    So for all of you streaming fans I have a question for you, does Netflix have a large selection of recently released movies? Does amazon? Or are they hiding the fact that they really focus on tv shows, and their new movie content is severely sparse. So the next time you want to see recent releases such as Wolfof Wall Street or American gangster you have 3 choices: buy the DVD/Blu ray, pay $6 on demand, or $1.20 for redbox

    Choice is yours.

    I will say though that the proximity of a redbox to my daily commute does dictate my likelihood to utilize it's services.

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