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 shouldn't be a condemning factor for any company, but it could be a red flag indicating something is off. Let's look at three companies that have seen a rapid increase in the number of shares sold short and see whether traders are blowing smoke or if their worry has some merit.

Source: The Wall Street Journal.

Can this company carry your portfolio?
Nothing says "inconsistency" in 2013 like network connectivity or infrastructure component suppliers. From quarter to quarter, companies like Juniper Networks and rival Cisco Systems (CSCO -0.37%) have remained anomalies in which spending shoots through the roof one quarter only to unexpectedly crash the next.

Over the past two months investors have certainly had cause for piling into Juniper on the short side, as the company offered up fourth-quarter revenue guidance of $1.2 billion-$1.23 billion that was a bit lower at the midpoint than the $1.23 billion Wall Street was expecting. To compound Juniper's problems, much larger rival Cisco announced in November that difficult-to-predict carrier spending habits would make things challenging over the near term. Cisco has been countering these networking hiccups with layoffs and other operational-improvement initiatives meant to boost margins while its top-line growth trudges along.

But is this pessimism warranted? Probably not so much as you'd think.

Although Juniper's near-term outlook may have disappointed investors, 2014 should be a fantastic year for connectivity-component and networking-equipment suppliers as the multiyear infrastructure upgrade initiated by practically every telecom service carrier begins to trickle down to these companies. We see this ongoing upgrade cycle come around every few years, but somehow investors seem to forget about it.

Ultimately, Juniper isn't exactly "cheap" at 16 times forward earnings with a growth rate of just 6%, but I believe its cost-cutting opportunities offer significant potential to beat earnings estimates throughout 2014.

A social butterfly blooms
Since debuting less than two months ago, shares of social-media network Twitter have exploded higher from an IPO price of $26 to more than $60 per share. Investors have had no qualms in sending shares higher, as they fully expect the surge in customer growth to attract advertisers who will pay through the nose to reach Twitter's diverse customer base.

I have some skepticism about Twitter and would tend to side with short-sellers in the interim. I wouldn't argue against the notion that Twitter's growing user base will drive top-line growth, but two factors keep me firmly on the outside looking in.

First, customer growth is already slowing at the social-media giant. According to its S-1 prospectus prior to going public, Twitter's user growth slowed from a 44% year-over-year increase in the second quarter to just 39% in the third quarter. Slowing user growth isn't necessarily bad news, but it makes maintaining a nearly $33 billion market cap difficult.

Secondly, where are the profits? I fully understand that Facebook (META 0.14%) and LinkedIn were given some sizable premiums before they delivered their first profits, but they both also had quite a dip in share price before those profits came around. Twitter hasn't yet proven to Wall Street that it can be profitable and is currently trading at 29 times next year's projected revenue. By comparison, Facebook, which is now extremely profitable and using mobile to its advantage, is valued at just 13 times next year's revenue. Furthermore, Facebook and Twitter offer a similar revenue growth rate.

All things considered, I don't see why investors would choose Twitter over Facebook here, given that Facebook is already profitable and is at least 50% less expensive than Twitter based on market value-to-revenue metrics.

Hitting the brakes on silver
Unlike Juniper and Twitter, which have both had incredible runs lately, metal royalty rights holder Silver Wheaton has had an abysmal year.

There are a number of reasons short-sellers have piled into Silver Wheaton. First, labor costs and mine build-out expenses have risen dramatically. While Silver Wheaton doesn't do any mining itself, those higher costs make it difficult for the companies it contracts with to boost or expand production, thus limiting Silver Wheaton's production yield. Further, metal prices themselves have languished as fear has been absent from the U.S. market and inflation has remained well under control. Finally, the beginning of the end for the Federal Reserve's quantitative-easing monetary stimulus program also serves as a reminder that silver's days as a potential hedge may be over in the interim.

Right now, fear among metal-miners is nearing a high point, and I have to say that I'm starting to feel a bit greedy, to paraphrase a "Buffettism."

One incredibly attractive selling point of Silver Wheaton is that it negotiates all of its contracts over the long term at a low fixed cost. Because of these contracts, Silver Wheaton is able to purchase most of its silver at a fraction more than $4 per ounce and gold at around $400 per ounce, then turn around and profit from the difference between these prices and current silver and gold spot pricing. It would take a huge drop in metal prices for Silver Wheaton not to be wildly profitable.

Silver Wheaton is also absolved from any additional mine costs beyond its up-front payment and perhaps build-out milestone installments. Upkeep and maintenance, as well as future expansion, are fully the responsibility of the mine owner and not Silver Wheaton.

With predictable costs, a decent yield of 1.8%, and long-term built-in cash flow, there aren't too many reasons for short-sellers to be excited here.