The Nasdaq's 3 Most Hated Stocks

The Nasdaq Composite (NASDAQINDEX: ^IXIC  ) may be showing its first vulnerability in more than a year due to weakness in social-networking stocks, but it's still up 20% on a trailing 12-month basis.

There is a laundry list of reasons why the Nasdaq has soared. This nearly unabated rally and a recent wave of merger and acquisition activity have drawn risk-on investors back into the market. That has been particularly true of the more volatile Nasdaq Composite, which has been heavily reliant on technology and biotech for its climb.

Historically low lending rates have played a crucial role in spurring that growth. Low interest rates allow businesses to borrow cheaply in order to hire workers and expand either organically or through acquisitions. The higher growth rate we've witnessed in many tech companies is a direct result of attractive lending rates.

Companies have also benefited from a general rebound in the economy. Although the initial federal estimate showed that U.S. gross domestic product rose just 0.1% in the first quarter, we have to take into account that exceptionally cold weather played a hand in nearly all of that weakness. Rapidly rebounding manufacturing data in March and April indicates the economy is ripe for ongoing growth.

Of course, plenty of investors are quite skeptical of the Nasdaq's rally, myself included.

Two primary factors stand out as particularly worrisome to rally skeptics. First, although a high percentage of companies are beating Wall Street's earnings-per-share estimates through a good chunk of earnings season, only about half are beating on the revenue front. Given that 2013 was the No. 2 year on record for share buybacks in terms of dollars, I'd quantify this action by corporate America as nothing more than a ruse to cover up weak organic top-line growth.

Second, optimism surrounding the six-year low in the unemployment rate ignores the fact that the jobs market remains rough. A falling labor-force participation rate masks the six-year stagnancy in nonfarm payrolls, while the mean out-of-work citizen will wait roughly 35 weeks before finding a job. That is hardly encouraging data.

With this in mind, let's 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  )

52%

World Acceptance (NASDAQ: WRLD  )

44.2%

SodaStream International (NASDAQ: SODA  )

34.5%

Source: S&P Capital IQ.

Myriad Genetics
Why are investors shorting Myriad Genetics?

  • The bet against Myriad Genetics remains similar to prior months. Skeptics are betting on further erosion in the Medicare reimbursement rate for the company's primary diagnostic product, the BRACAnalysis gene test used to identify BRCA 1 and BRCA 2 genes, which bear a higher risk in women of developing breast and ovarian cancer. While only a low double-digit percentage of revenue comes from Medicare, it still represents an area of concern for Myriad Genetics down the road. In addition, a Supreme Court ruling last June invalidated some Myriad patents that protected its BRACAnalysis test from competitors, allowing those companies to introduce similar diagnostic tests within days. Short-sellers are counting on this tougher competition to eat into sales of Myriad's lead product.

Is this short interest warranted?

  • If you happened to catch last night's earnings release that is indeed the scent of short-sellers being burned. Myriad reported a revenue increase of 17% to $182.9 million in its fiscal third quarter, along with generally accepted accounting principles EPS of $0.48. Wall Street was expecting just $0.45 in EPS and about $174.7 million in revenue. It certainly helped that prior fears of a nearly 50% reduction in Medicare reimbursement rates were demonstrably reduced to a cut of just 22%. Adding icing to the cake, Myriad also boosted its full-year sales and EPS forecast to $770 million-$775 million and $2.37-$2.40 from its prior forecast of $740 million-$750 million and $2.09-$2.12. With a number of new diagnostics on the horizon and its Medicare reimbursement fears more than priced in, Myriad could continue to burn short-sellers over the interim.

World Acceptance
Why are investors shorting World Acceptance?

  • The growing pessimism against pawn shop and payday loan operator World Acceptance stems from the mid-March announcement that it is being probed by the Consumer Financial Protection Bureau for possible violations of consumer protection laws. The company at the time said it believed its "marketing and lending practices are lawful," but clearly short-sellers aren't buying it. If found guilty of wrongdoing, World Acceptance could be required to pay a fine. This threat may act as a financial overhang that negatively affects its business model in the interim.

Is this short interest warranted?

  • Any potential for legal action by the CPFB against World Acceptance will remain a gray cloud and serve as more than enough reason for short-sellers to pile onto the company. Although World Acceptance increased its net income 3% in the fourth quarter, revenue was flat --signaling that further erosion could be on the horizon. As long as the CPFB is targeting the payday loan business, I would suggest treading cautiously around World Acceptance.

SodaStream International
Why are investors shorting SodaStream International?

  • Carbonated-beverage machine maker SodaStream returned to the top three most hated stocks this past month as investors continued to digest its latest earnings report, which showed fourth-quarter revenue rising 26% year over year but net income diving more than 90% to just $700,000. As in most holiday quarters, SodaStream saw a surge in lower-margin system sales, while higher-margin Co2 refills dipped. Skeptics view this as an inherent growth problem and suspect that competition from a larger rival, or recently announced deals in the carbonated-beverage space, could adversely impact SodaStream over the long run.

Is this short interest warranted?

  • I believe SodaStream has a genuine chance to burn short-sellers because of its niche position within the carbonated beverage machine segment. Investors should understand that it's natural for margins to dip in the fourth quarter due to increased system sales around the holidays, and that double-digit top-line growth still appears to be in the forecast. SodaStream has developed a strong enough following that it's likely to either be purchased for a substantial premium or excel over the long run due to its first-in-class beverage system.

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  • Report this Comment On May 08, 2014, at 6:32 PM, csqrd wrote:

    I appreciate the article but the basic premise is frankly ridiculous. I want to find good solid companies with heavy short interest in order to accumulate shares at a bargain. I need to consider the bear argument being made but typically, I find a lot of momentum traders piling on, not significant long term conditions building that would devalue the company. Keep this kind of thing coming but recognize that for some of us, it's a buy, not an avoid signal. thanks.

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