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.

You can dig this stock
Oil prices are headed to their highest level in nearly a year, and short-sellers are building up a position in National Oilwell Varco, a provider of oilfield equipment and technologies designed to facilitate the recovery of liquid and gas assets beneath the soil. I know what you're thinking, and no -- it doesn't make a lot of sense to me, either.

Source: Hakon Thingstad, Flickr

My best guess is that short-sellers are disappointed with the sequential quarterly drop in EPS in the first quarter, as well as a 6% drop in sequential revenue. Year over year, though, revenue rose 9% and EPS expanded by double digits. Furthermore, National Oilwell Varco's backlog for capital equipment hit another record, up 1% to $16.35 billion. This isn't rocket science: More shale deposit finds and offshore exploration coupled with higher oil prices is only going to encourage exploration and production companies to drill now and utilize National Oilwell Varco's industry leading drill technologies.

The end result is that National Oilwell has some of the strongest pricing power in the industry. Even when oil prices dipped in 2012 the company was able to maintain pricing since so few competitors exist. Higher oil prices over the past few months caused by political tension in Iraq and Russia, and the natural cyclical swings of the oil cycle in the summer, have simply been an added bonus for shareholders.

With National Oilwell Varco spinning off NOW, the company's distribution segment, investors are also going to have better earnings and revenue clarity. This spinoff should allow investors to take advantage of its slower but more consistent distribution operations (NOW), or its faster growth but slightly more oil price-dependent rig technology segment (National Oilwell Varco). At a forward P/E of less than 12, I'm not exactly sure what pessimists are seeing here, but I'm certainly not on the same wavelength as they are!

Up in smoke
When it rains, it pours -- just ask shareholders of Insys Therapeutics, who have witnessed their shares drop by about half in just the past three months. As my Foolish colleague George Budwelll summarized just a few days prior, there are two primary reasons why Insys' short interest now tops 50%. 

Source: Okko Pyykko, Flickr

First, an investigation was opened in May that alleges a single doctor in Michigan was responsible for writing about 20% of Insys' prescriptions for Subsys, a cancer pain medication. According to the ongoing fraud investigation, the doctor was in many cases prescribing the pain med for off-label ailments, which is a big no-no if true. So investors are clearly concerned that somewhere in the neighborhood of 20% of Subsys' revenue could be wiped out in the immediate future, and the abuse potential of the drug may be brought under further scrutiny.

Also, Insys is sparring with its supply and distribution partner Mylan (MYL) over its other FDA-approved therapy, Dronabinol, a generic version of Marinol, a preventer of nausea and vomiting caused by cancer meds. Because Dronabinol is a synthetic version of the cannabinoid THC, investors have piled into INSYS as the next great marijuana stock. But Dronabinol sales have been practically nonexistent with the two sides unable to agree on pricing of the drug.

What Insys' valuation really comes down to is the value of Subsys since it comprised 98% of the company's first-quarter revenue. Knocking out 20% of its revenue in a worst case scenario with gross margins of 89% should still leave INSYS profitable. What this means is Insys' downside reaction due to the allegations of fraud were likely overdone.

But I'm still not a huge fan of the company simply because of the emotional trading that its ties to marijuana-based drugs will bring. Until we have better clarity on Subsys sales (even with the company projecting solid growth in Q2) I would suggest sticking to the sidelines. 

Bed Bath & Beyond comprehension
There was a time when Bed Bath & Beyond used to be on my own short-sale list, but that time has come and gone as I've become a homeowner and discovered the wonder that is my local Bed Bath & Beyond store.

Source: Mike Mozart, Flickr

My big assumption when I was suggesting that Bed Bath & Beyond made an intriguing short-sale was that growth in the housing market still looked bleak and that this lack of growth would hamper sales. The fact of the matter is that eventual weakness in the housing market caused by rising interest rates could actually benefit Bed Bath & Beyond, which may see a surge in business from homeowners who want to remodel or change the look of their interior and who simply can't afford to move.

The company's results in April certainly left a lot to be desired from the standpoint of shareholders with growth estimates being scaled back amid a tepid consumer spending environment. But again, consider that Bed Bath & Beyond has transformed itself into an entity set to capitalize more on remodels than new home furnishes. Don't get me wrong, I bought a number of items to furnish my house at my local Bed Bath & Beyond, but the shoppers I personally continue to see at these stores are looking to freshen the image of their home. As the housing sector growth begins to taper off, we could actually see Bed Bath & Beyond gain traction.

At just 11 times forward earnings and with the expectation of mid-single-digit sales growth this year I'd suggest shares are ripe for the picking, not short-selling. It remains to be seen what the next couple of quarters will hold, but over the long run I expect it'll amply reward patient investors.