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

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

Apr 14, 2014 at 1:45PM

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 March 14 to March 31

Short Shares as a % of Float

Plug Power (NASDAQ:PLUG)

37.2%

30.5%

Geron (NASDAQ:GERN)

80.5%

15.9%

Urban Outfitters (NASDAQ:URBN)

44.7%

5.4%

Source: The Wall Street Journal

Is 4,760% too much?
If you ask short-sellers, they're liable to tell you that the 4,760% run that Plug Power has seen over the trailing 12-months from its 52-week lows might be a bit excessive.

Plug Power is a developer of fuel-cell systems, which run on hydrogen gas, and it recently struck a landmark deal with retail giant Wal-Mart to deliver 1,738 fuel-cell systems to power forklifts in six select Wal-Mart warehouses throughout the United States. The deal solidified Plug Power's technology as viable, and it could also put the company in line to deliver its first annual profit by 2015.

But there's another side to the fuel-cell story that short-sellers have honed in on: long-term viability. Even with Plug Power bagging the elephant Wal-Mart, the big question on investors' minds is whether it can continue to garner new contracts moving forward. In other words, Plug Power can only boast about its Wal-Mart deal for so long before it will need to make a name for itself with other potential clients.

The other question mark is whether Plug can move beyond forklifts. Let me clear that there is nothing wrong with Plug Power focusing its efforts on fuel cells for forklifts. This is a big enough market for the relatively small Plug Power to establish a solid revenue stream, and I see nothing wrong with that. But I believe skeptics want to see Plug diversify its operations and take that next step into the considerably more lucrative auto market. It can already claim BMW and Daimler as clients, but short-sellers clearly want to see a large increase in fuel-cell proliferation before they're sold on the idea of Plug Power's success. 

I tend to fall somewhere in the middle in that I'm beginning to come around to the idea that Plug Power's fuel-cell technology is viable and here to stay; but I also believe that its forward P/E of nearly 150 is downright scary. For now I'm perfectly happy watching from the sidelines until the volatility comes way down.

Can imetelstat make a comeback?
With the exception of the past month the biotech sector could do no wrong -- but don't tell that to shareholders of clinical-stage biopharmaceutical company Geron, which was pummeled last month after announcing a full clinical hold on its only experimental compound, imetelstat, which is being tested as a possible therapy for myelofibrosis, polycythemia vera, and multiple myeloma.

The culprit to the company-run clinical halt, and subsequent partial hold on enrolling new patients in investigator-sponsored studies, was the finding of persistent low-grade liver-function abnormalities that the Food and Drug Administration was concerned could cause long-term and/or irreversible liver damage.

So, what's next for Geron? That really depends on imetelstat and the FDA's position on its current clinical hold.

On one hand imetelstat could have a bright future as a myelofibrosis treatment. Current FDA-approved therapies to treat myelofibrosis are JAK2 inhibitors, which provide clinical improvements but don't deliver partial or complete responses in patients. Imetelstat, however, has delivered partial and complete responses in patients -- and complete responses are incredibly rare for myelofibrosis patients.

But there's always the issue of safety, and the FDA puts safety above efficacy in every instance. If imetelstat isn't allowed to return to clinical studies then Geron is nothing more than an empty shell with $66 million in cash plus the $90 million it grossed from a stock offering in January. Geron would be starting from scratch and short-sellers would likely reap huge rewards.

As I stated last month, my personal opinion is that imetelstat will be removed from its full clinical hold in due time, but with much tougher safety requirements. I suspect such a move could also doom the therapy to "last resort" status because of the liver abnormality concerns, but it would be better than the alternative of being scrapped altogether. While there certainly is upside potential, the risk of an unfavorable FDA view is more than enough to keep me far away from Geron.

The never-ending winter
This was a winter to forget for America's retailers, with the polar vortex capping customer traffic and requiring a number of retailers to adjust their guidance downward. Even prior to winter many retailers were struggling through a weaker period of consumer spending -- especially teen retailers.

For Urban Outfitters, this wasn't the case. In March, the company, which predominantly focuses on a teen and young-adult audience, reported record revenue of $906 million, up 6%, as well as record net income of $89 million. Urban Outfitters' CEO Richard Hayne attributed the strength to consumer acceptance of new fashion offerings in its Anthropologie and Free People brands.

Yet even with record results, Hayne was cautious about future growth prospects -- and rightly so, given the traditionally weaker first quarter.

To begin with, I'm not sure any apparel and accessories retailers will escape the negative effects of the polar vortex, with the exception of online retailers. I suspect Urban Outfitters will face many of the same inventory headwinds as the rest of the young-adult retailing crowd coming out of this quarter, and I wouldn't be surprised to see its margins dip in Q1.

Also, while I'm happy to see strength in the company's outlying brands, Anthropologie and Free People, I'm a bit worried by the 9% decline in comparable retail segment sales in the fourth quarter at its flagship Urban Outfitters stores. My concern is that the success of the company over the long run revolves around its flagship brand, not the outliers. I don't think it'd be wise to judge Urban Outfitters' progress based on Q1 for obvious reasons, but I'd like to see same-store sales at the Urban Outfitters brand progress by the end of the third quarter.

Overall, at 15 times forward earnings, Urban Outfitters isn't particularly expensive, but weather-related weakness and the potential for ongoing weakness in its core brand are enough to suggest you stick to the sidelines until after Urban's first-quarter report.

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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 has no position in any companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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