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 have tended to trend up 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, even with dividends included, between 1983 and 2006, 64% of stocks underperformed the Russell 3000, a broad-scope market index.

A large influx of short-sellers shouldn't be a condemning factor to any company, but it could be a red flag from traders that something may not be as cut-and-dried as it appears. Let's look at three companies that have seen a rapid increase in the amount of shares sold short and see whether traders are blowing smoke, or if their worry has some merit.

Source: The Wall Street Journal.

Buyer's remorse
It was just last month that Oracle (ORCL -2.25%) agreed to purchase software-as-a-service cloud Eloqua (NASDAQ: ELOQ) for $871 million and every other SaaS provider soared to the heavens with the expectation that it was next. Investors in ExactTarget may just want to keep their expectations in check, however, as this company is still a long way from meriting its frothy valuation.

ExactTarget's most recent quarterly results demonstrated the same rapid growth we've seen from numerous other SaaS cloud providers: 35% revenue growth, a boosted full-year revenue outlook, and a never-ending pile of acquisitions. What worries me about the slew of consolidation in the cloud software arena is the potential for merger-related hiccups, as well as the masking of little, if any, profits and relative small occurrences of organic growth.

Contrary to popular belief, cloud software companies are susceptible to an economic slowdown. The passing of the fiscal-cliff-averting bill should at least help tech sector spending, but for companies like ExactTarget that are still at least two years away from being profitable, the stakes are much higher. This is a situation where I happen to share short-sellers' skepticism.

Criminally insane
Under normal circumstances I would fully encourage short-sellers to closely examine and scrutinize any business that's reliant on the government for a good chunk of its income. The GEO Group, an operator of correctional and detention facilities, is one of the very few exceptions to the rule.

One reason I say that is that GEO Group, as of Jan. 1, 2013, is now operating as a real estate investment trust, and as such will be required to pay out at least 90% of its profits in the form of a dividend. With the passing of the fiscal cliff deal, dividend income was shielded from being treated as ordinary income and received only a modest increase in taxation for America's highest earners. This means the share price is likely to be buoyed by income-seeking individuals in search of a solid yield.

Also, if you think about it, GEO Group is operating in a near-necessity space. The need for incarcerations in the U.S. is only increasing, and overcrowding in prisons has created an oligopoly of sorts for the few large correctional facility operators like GEO Group. GEO should easily be able to pass along rising costs to the U.S. government without much fear of reprisal since it knows few other alternatives exist. This is not a company I'd consider betting against.

Get the paddles?
I certainly can't blame short-sellers for dog-piling onto Boston Scientific, as it's been years since the company was consistently profitable and free of recalls and lawsuits pertaining to its implantable stents. But are short-sellers correctly forecasting further problems from Boston Scientific? I wouldn't jump on that bandwagon just yet.

Boston Scientific's cardiovascular products, which have been hammered by the introduction of new devices from St. Jude Medical (STJ), actually could benefit from a recent FDA report that claims that Durata, one of St. Jude's defibrillator leads, may be inadequate and could eventually lead to a recall. While I'd rather Boston Scientific's products win over physicians organically, I'm sure investors would gladly accept the surge in business.

Also, don't discount Boston Scientific's proactive stance on cost-cutting. The company announced a round of job cuts in the summer (predominantly in the United States) while shortly thereafter noting it would be making a $150 million investment in China and creating jobs overseas in what I assume is in direct response to the new 2.3% medical device excise tax created with the Affordable Care Act. These overseas jobs should result in cheaper labor and better margins in the long run.

Foolish roundup
This week it's all about necessities and pricing power. The GEO Group clearly has the necessity aspect under its belt. ExactTarget, on the other hand, looks like a dime a dozen in a very crowded market. Boston Scientific could be the wild card of this bunch given its erratic earnings history, but also the underperformance of its peers recently.

What's your take on these three stocks? Do the short-sellers have these stocks pegged, or are they blowing smoke? Share your thoughts in the comments section below.