Short interest is a key metric investors should pay attention to. When short interest is particularly high, it's often indicative of real problems at a company. Yet, highly shorted stocks can be prone to periodic, powerful rallies. When a highly shorted stock begins to move higher, short-sellers can be forced to cover their bets -- buying stock and driving the price higher still.
BlackBerry's BB10 failure
More than 30% of BlackBerry's shares have been sold short. The Canadian handset maker has been a favorite among short-sellers for years now, and those that have bet against it have been right. Over the last five years, BlackBerry shares have lost more than 90% of their value.
The rise of iOS and Android has more or less obliterated BlackBerry's smartphone business, and it's unlikely that it will bounce back anytime soon. The company's BB10 operating system, intended to rejuvenate BlackBerry, has failed to catch on, and has sold below expectations.
Given that its market share has eroded so significantly, BlackBerry lacks a robust app ecosystem, because developers won't waste their time coding for the platform. The disadvantage appears too significant for the company to overcome -- its announcement that it will seek strategic alternatives, including a sale of the company, seems to indicate as much.
Should BlackBerry be acquired, short-sellers will take a big hit. Yet, if that doesn't happen, BlackBerry's business should continue to decline.
3D Systems: Too much hype or the next big thing?
Unlike BlackBerry, 3D Systems isn't a business in decline. Rather, it's shorted because investors believe the company gets too much hype.
3D Systems is a play on the emerging technology of 3-D printing. As a leader in the industry, 3D Systems stands to benefit from the widespread adoption of the technology. In theory, 3-D printers have the potential to revolutionize everything -- from manufacturing to food preparation to health care.
Short-sellers see the stock as overexposed. With a price-to-earnings ratio of about 116, roughly eight times the broader market, 3D Systems certainly isn't a cheap stock from a value perspective.
William Blair analyst Brian Drab has been bearish on 3D Systems for months. In May, he downgraded the stock to underperform, and reiterated that rating in July. In an appearance on Bloomberg, he argued that investors had unrealistic expectations.
Drab characterized 3-D printing as a niche technology, suggesting that it was "ridiculous" to assume that 3-D printers would find their way into everyone's home. While he described the technology as "fascinating," he believed the recent rally in the stock was overdone.
Evidently, lots of investors agree -- almost 30% of 3D Systems' shares have been sold short. Yet, unlike BlackBerry, 3D Systems' bears have been burned. Shares are up nearly 90% over the last year.
Trulia is a high-flying tech stock dependent on the real estate market
Trulia, too, has had an impressive rally over the last year, though it hasn't even been trading for a full 12 months. The website went public last September, and shares are up almost 70% since then.
Investors might be inclined to lump Trulia with other recent Internet IPOs like Facebook and Groupon. But in reality, Trulia might be better thought of as a play on housing. Trulia exists as an online marketplace for buyers, sellers, renters and landlords.
As long as the housing market in the U.S. is booming, Trulia should continue to perform well. On the company's last earnings call, Trulia's CEO said that the U.S. housing market appears to be in a recovery, and that all national metrics look "promising."
But that was back in July. Since then, housing data has taken a turn for the worse. Data released this week showed that pending home sales fell in July -- the second straight monthly drop on record. The rising mortgage rates may be the culprit, as the interest rate on a 30-year mortgage has spiked from roughly 4.1% in June to over 4.7% in August.
Higher mortgage rates drive down housing affordability, which could put a damper on an online real estate broker like Trulia. If that's the case, those shorting the stock could be right. Roughly 22% of Trulia's floating shares have been bet against.
Investing in heavily shorted stocks
Heavily shorted stocks present an interesting opportunity to investors. On the one hand, the stock is being bet against for a reason -- typically, market participants see a flaw in the company's business model.
But the herd isn't always right. Often, highly shorted stocks can prove their doubters wrong. When that happens, shares can rapidly appreciate, as the errant short-sellers are forced to cover their bad bets.
BlackBerry, 3D Systems and Trulia all present this opportunity to would-be investors. But whether they prove to be the next Tesla or the next Eastman Kodak remains to be seen.
Sam Mattera has no position in any stocks mentioned. The Motley Fool recommends 3D Systems, Facebook, and Tesla Motors. The Motley Fool owns shares of 3D Systems, Facebook, and Tesla Motors and has the following options: short January 2014 $36 calls on 3D Systems and short January 2014 $20 puts on 3D Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.