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

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 their worries have merit.

Source: The Wall Street Journal.

Has colon cancer met its match?
We're getting close to crunch time for cancer diagnostics company Exact Sciences, which has developed a state-of-the-art screening tool known as Cologuard to aid physicians and patients with the early detection of cancerous and precancerous polyps and adenomas of the colon.

What's unique about Cologuard is that it's entirely noninvasive. A patient merely sends a stool sample to Exact Sciences' laboratory, where it's analyzed for abnormal DNA. The colon naturally sheds DNA, as do cancerous growth and precancerous polyps in the colon. Cologuard is designed to look for signs of altered DNA patterns from cancerous lesions and precancerous polyps and return any positive readings to physicians so the patient can be screened further via a colonoscopy. To be clear, Cologuard isn't designed to replace a colonoscopy, but merely to provide a noninvasive first step for potentially earlier colon cancer detection.

According to data released from Exact's DeeP-C study, as reported in The New England Journal of Medicine earlier this year, Cologuard's sensitivity of 92% trounced that of the current noninvasive fecal immunochemical screening test, which came back with a sensitivity of 74%. Cologuard was also able to detect 69% of patients with polyps and high-grade dysplasia, compared to just 46% for the standard treatment.

FIT = fecal immunochemical test. Source: Exact Sciences. 

Where investors and Wall Street skeptics came out of the woodwork was in the system's detection of advanced precancerous lesions. Sensitivity for Cologuard was 42%, while the control test sensitivity was a mere 24% for advanced precancerous lesions. Skeptics assume that this low value will reduce Cologuard's chances of being used often. 

Still, I suspect Cologuard will radically improve patient quality of life, and I personally expect a Food and Drug Administration approval to be around the corner. In March, the FDA's Molecular and Clinical Genetics Panel recommended Cologuard for approval in a 10-0 vote, signaling that it clearly represents the best pre-screening option in colon cancer detection today. Given that colon cancer is the second-leading cause of cancer-related deaths in the U.S., I can't help but believe Exact Sciences has a chance to really hit a home run here while simultaneously improving patients' lives.

In sum, while short-sellers may prey on nervous jitters prior to the FDA's decision to approve or reject Cologuard, I believe any dip could represent an intriguing buying opportunity for health-care-savvy investors.

Anything you can do, I can do better
Should we really be surprised that one of the companies most hated by consumers has drawn the ire of short-sellers?

Comcast, one of the nation's largest triple-play providers (phone, Internet, and TV), made waves in February when it announced a massive $45 billion buyout of Time Warner Cable (NYSE: TWC), opening the door to create the nation's largest cable-provider based on subscribers. Of course, everything depends upon whether the Federal Trade Commission approves the deal.

Source: Mr. TinDC, Flickr.

On the surface the deal appears to make sense. Comcast and Time Warner do not compete in overlapping markets, thus Comcast would expand its national reach without worrying the FTC that it is reducing competition. It could also give Comcast better footing as it attempts to lure away DIRECTV customers. Furthermore, cost synergies from the merger could eventually save Comcast a lot of money for use in paying down its $47.4 billion in debt -- or perhaps boosting its current dividend, which averages a modest yield of 1.7% annually.

On the other hand, with Comcast almost universally disliked by the public, the creation of a mammoth cable operator might be too much for the FTC to bear. Even if the deal does go through, it's not as if Comcast is going to recognize those cost synergies overnight. It's probably going to take three years before we see meaningfully positive benefits from this proposed merger.

While cable operators have essentially been infallible in the eyes of investors for years, I'm going to side with the short-sellers here: I see too many questions and not enough answers at the moment. The ongoing debate over net neutrality, coupled with generally low customer loyalty and a large pile of debt, simply doesn't sit well with me, and it's certainly not going to help Comcast improve its image. Unless Comcast shares drop significantly, I'm perfectly comfortable sticking to the sidelines.

Star Trek becomes reality
Like Exact Sciences, Organovo Holdings has the potential to completely change the game for physicians and patients. Organovo's possible claim to fame is a proprietary platform that can engineer human tissue and may one day be used to rapidly test medicines on various cancer types and even grow human replacement organs (many, many years down the road).

Source: Kiran Foster, Flickr.

Earlier this year, Organovo announced that it had delivered its first 3-D tissue product to top research scientists around the globe, ahead of schedule, for what it anticipates will be a late-year launch for its liver assay test. By sending out samples to top researchers, Organovo is looking for hands-on ways to improve its product. Investors can sense that a consistent stream of revenue could be right around the corner, and the validation of possibly having an approved product can go a long way toward sustaining or growing a company's valuation in the biotech and bioengineering sector.

Investors should understand that being a pioneer is no easy task. Organovo will still face a number of challenges with its liver assay test, including the actual launch itself. It's one thing to provide some 400 samples to researchers and have them critique your product for improvement; it's entirely different when you're attempting to get physicians and universities to purchase the item. In other words, it might be wise for investors to keep their expectations tempered over the first couple of quarters.

Another factor worth monitoring is Organovo's cash burn. Although the company has nearly $50 million in cash on its balance sheet, which is more than enough to fund its current operations, at a burn rate that I estimate will hit $15 million in 2015 and expand to $20 million 2016, Organovo may eventually need to seek funding through a dilutive secondary offering. While such offerings aren't uncommon among biotech stocks, it's another reason for investors to keep their expectations under control.

Considering that we're getting closer to Organovo's possible product launch, I'd suggest it's far too dangerous to be short this stock, given the euphoria that surrounds the company. However, the intermediate-term fundamentals (one to three years) would appear to favor skepticism.