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 if their worries have merit.

Source: The Wall Street Journal. 

Lacking "spirit"
If there were ever a reason to make a list of pros versus cons for an airline, then Spirit Airlines would likely be the perfect candidate.

Source: Spirit Airlines

In the plus column, Spirit is a low-cost leader in that it lures fliers in with dirt-cheap ticket pricing and then makes up the difference by charging for optional items that major airlines don't. With Spirit you pay for everything from food onboard the airplane to your carry-on luggage. Best of all, Spirit offers a discount for checking in and paying for your items ahead of time. In other words, Spirit has reduced customer-representative interactions, which saves the company money and allows more of the high-margin service fees to go directly to its fattening bottom line.

Another aspect you have to like about Spirit is its debt-free balance sheet. It's remarkable that Spirit is debt-free, because it's working with one of the youngest fleets in the skies. This should translate into fewer repairs over the near term and therefore more planes in the skies instead of the garage. Having $544 million in cash with no debt also gives Spirit the flexibility to expand if an advantageous opportunity arises.

On the flip side, I'm a firm believer in brand loyalty and customer opinions. In a true case of "you get what you pay for," Spirit ranked the highest in terms of customer complaints in 2014. Although the airline describes itself as misunderstood, it's pretty clear that Spirit's "optional" fees aren't well understood by consumers. Although these bare-bones ticket prices are great for attracting new customers, keeping customers loyal could prove difficult.

The other aspect of Spirit that demands investors' attention is its forward P/E of 17. Historically, a forward P/E of 17 isn't far out of line with the average of the S&P 500, and it isn't particularly high considering that Spirit could likely grow at 20% per year over the next five years. But Spirit's P/E is significantly higher than the sector average which is concerning given that oil prices are rising and the airline sector is notoriously cyclical and often a poor long-term investment.

I like Spirit as a business and view it as an opportunistic one- to three-year kind of trade, but I see too many long-term clouds to hang on beyond that. At its current price, I'd suggest waiting for a pullback before considering this as a possible addition to your portfolio.

Binge much?
Just in case you thought binging was strictly for the holidays, commercial real-estate investment trust American Realty Capital Properties is showing us that it can be a year-round thing.

Source: Darden Restaurants

American Realty Capital has purchased CapLease, ARCT IV, Cole, and, most recently, $1.5 billion in Red Lobster properties. Acquisitions help drive growth, but normally there's an integration period for smoothing out all the kinks. American Realty Capital has instead been purchasing assets on an almost at-will basis and financing its activities with dilutive share offerings that don't exactly have its largest shareholders pleased.

In early June, Marcato Capital Management, an investment firm that owns about 21.8 million shares of American Realty Capital, sent a letter to American Realty Capital's management team informing it of the perceived negligence of its fiduciary responsibilities by issuing shares at $12 per share and eventually upping the offer amount by 20% after stating in previous conference calls that it had no intention of issuing shares at such a low per-share price point. Marcato also criticized the Red Lobster properties acquisition, given that the seafood chain's sales have been in the dumps for the better part of six years.

While activist investors often help improve the value of a company's share price, I don't always agree with their argument. However, I believe Marcato's concerns are well-founded and investors have every reason to be skeptical of American Realty Capital's current 8% yield. With interest rates projected to begin rising in 2015 and American Realty Capital having to focus on integrating four large purchases almost at once, I believe it could be years before we see any substantial benefits from its acquisition binge. This means that despite its current discount to its peers, I'd keep my distance from this high-yielder for the time being.

Back on the shelf
Ross Stores' commercials may advertise that consumers "Got it at Ross," but its slowing same-store sales would beg to differ.

Source: Daniel Oines, Flickr

In Ross Stores' most recent quarterly results the company reported a 6% increase in net sales, primarily from the opening of new stores, as comparable-store sales slowed to just 1% growth. As CEO Michael Balmuth noted, tight cost and inventory controls were the primary reason that Ross was able to maintain its EPS growth as poor weather during the first half of the year sapped sales. Even though its EPS rose by 7%, the company's operating margin fell slightly to 14.6%. 

The big question going forward is whether or not Ross' same-store sales slowdown is endemic of consumers no longer valuing the brand as highly as before or whether the business is simply maturing. As for me, I side with the latter idea because Ross has two key advantages over its peers.

First, Ross has a successful game plan when it comes to merchandise purchases. Ross Stores specifically waits until later in the season to make its buys and often targets vendors that are overstocked with brand-name merchandise in order to secure the best deals. Ultimately, the Ross shopper isn't looking to be the first to wear a given design. Ross' purchasing strategy simply helps shoppers get designer clothing at reasonable prices, and it keeps customers coming back.

Secondly, Ross can undercut its peers when it comes to brand-name pricing. There's a big difference between being a discount store and being a store with brand-name merchandise that discounts. Ross falls into the latter category, helping to satisfy consumers' demand for brand-name clothing and accessories.

In sum, investors shouldn't blame Ross for a weather-induced weaker quarter or punish the company for maturing. I still see plenty of potential for growth here if long-term investors are patient.