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.

Will Lowe's head lower?
Following its first-quarter report in May, short-sellers have made it clear, with a 140% increase in short interest, that they don't believe Lowe's can meet its prior guidance.

Source: Lowe's.

For the quarter, Lowe's reported that colder than expected weather restricted its comparable-store sales growth to just 0.9%, with 2.4% overall sales growth. A nearly 25% rise in adjusted earnings per share was aided by the company's repurchase of an astounding $850 million of its stock during the quarter. Fewer shares outstanding can boost EPS on a comparable basis, but if a company's share price drops it winds up being perceived as a waste of free cash flow. Lowe's did mention, though, that its May performance was looking up, and that it remained on target to reach its fiscal 2014 goals of 4% comparable-store sales growth and adjusted EPS of $2.63.

What might finally be hitting home for investors is that 5% sales growth and 4% comparable-store growth, or should I say organic growth, may not merit what equates to a valuation of 17 times projected 2014 EPS.

Lowe's has a few things working in its favor, including tight cost controls that are helping to boost margins, along with some degree of shareholder give back in the form of hefty share repurchases and a current 1.9% annual yield (which was raised by 28% a little more than two weeks ago). However, two things that have always worked against Lowe's, and where rival Home Depot (HD 0.53%) has the edge, are product mix and technology.

First, Lowe's has a greater reliance on appliance sales than does Home Depot. When the housing market is doing well this isn't a crutch for Lowe's, but the company's heavy weighting toward lower-margin appliances can become a sticking point in stagnant or contracting housing environments. Given how choppy mortgage originations have been in relation to even the slightest interest rate increases, I'd suggest Home Depot has a better product mix aimed at keeping its margins stable if new home sales growth stalls out.

Also, Home Depot has invested heavily in point-of-sale technology, which has translated into notable sales growth and a well-trained staff. I'll give credit to Lowe's for its MyLowe's card which will help it hone in on customers' needs and perhaps guide the company toward more personalized shopping experiences, but overall I'd give the technology edge and convenience factor to Home Depot as well.

Long story short, short-sellers have cause to be skeptical, but until there's a fire there's probably no need to call the fire department.

Prospecting in biotech
Wholly clinical-stage biopharmaceutical company Provectus Biopharmaceuticals only debuted on the NYSE Arca exchange a month ago, moving from the over-the-counter boards, but it has garnered a lifetime's worth of criticism in that short time.

Source: U.S. Army RDECOM, Flickr.

The primary allure for optimists in Provectus is its clinical-stage melanoma drug PV-10. According to data released in October 2012 from Provectus' midstage study, 51% of patients injected with PV-10 had an objective response: 26% with a partial response and 25% with a complete response (no trace of cancer detected). Including those who exhibited stable disease, total disease control was 69%. These results were incredibly promising, and PV-10, as expected, was much more effective in patients when their melanoma was discovered in stage three rather than stage four. Median overall survival for stage three patients was just beyond a year, while it was 7.3 months for stage four patients.  

So if the data is so good, why did Provectus plunge as much as 90% at one point over just a few days last month? The evident answer to that question, and the reason for the daily collection of possible class action lawsuits against the company, is its failure to garner the breakthrough therapy designation from the Food and Drug Administration. This denial essentially means that PV-10's only way to market is through a costly and long phase 3 study. 

However, what really has short-sellers salivating and other investors like myself who are on the sidelines watching this story develop confused, is the unexplained delay between the company's phase 2 study and the beginning of phase 3 enrollment. Provectus has announced that it plans to discuss how to implement its PV-10 phase 3 study this week during a conference call; nonetheless, it has been years since the company reported initial PV-10 data, yet management has taken no action to advance the drug. Honestly, it's just a bit weird that management has waited this long, especially considering how positive the data turned out to be.

It's obvious that the FDA and Provectus haven't been on the same wavelength before, which allows me to remain skeptical of this company until I see patients being enrolled and dosed.

Will these two figures doom Sirius XM?
What a difference five years makes if you're a Sirius XM shareholder. In that time Liberty Media (FWONA) has become a major stakeholder in Sirius XM and given shareholders in the satellite radio company a reason to believe there's always a parachute ready in case U.S. auto sales fall off a cliff.

Source: Claire P., Flickr.

With a Liberty Media buyout off the table after it announced plans to split into two separate businesses earlier this year, optimists have focused on the bread and butter of the Sirius bull case: subscriber growth. In the first quarter Sirius added 266,799 subscribers to reach 25.8 million total subs, up 6% from the previous year. Even more important, free cash flow increased 56% to $223 million from the year-ago quarter and adjusted EBITDA climbed to a fresh record of $335 million. Sirius XM also reaffirmed its full-year forecast of more than $4 billion in revenue and 1.25 million additional subscribers from where it began the year. 

The good news here is that there is no true satellite alternative to Sirius XM, which translates into fantastic pricing power for the company. This gives it the ability to boost prices every so often in order to provide cash flow for infrastructure upgrades, debt repayment, or simply a boost in margins.

However, Sirius XM also must overcome two particularly disturbing figures if it's to succeed.

First, Sirius carries $3.3 billion in net debt. Rather than repurchasing its own shares, I'd much prefer to see Sirius whittle away at its debt so that when the next recession comes, investors won't have to bite their nails wondering whether Sirius will survive.

Second, the psychological decline to a single-digit growth environment following years of double-digit growth might be a call for optimists to hit the exits with Sirius valued at close to 28 times forward earnings. Again, we're talking about a company with pricing power, but we're also starting to see a bit of U.S. market saturation. That could limit Sirius' upside over the interim.

For now, I'm sticking to the sidelines, as I deem the company fairly valued, considering its growth potential and risks. I'd consider revisiting it in three to six months.