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 that 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 their worry has some merit.

Source: The Wall Street Journal.

A cloud-based tug-of-war
What do you get when you pit a cloud-based health-care solutions provider against a sea of rabid value-investors? The answer is a 126% increase in your short interest over the last couple of weeks of December!

In the first week of December, Veeva -- whose cloud solutions include Veeva CRM and Veeva Vault, for the management of content-focused processes like clinical trials and manufacturing for life science companies -- reported another quarter of impressive growth. Veeva saw total third-quarter revenue climb 54% to $55 million as subscription-based revenue increased 95% to $38.9 million. Subscription revenue is incredibly important, because cloud-based companies rely on recurring revenue to drive cash flow and assist them when forecasting annual capital expenditures. Quarterly profit, however, was a mere $0.06 per share. 

On the flip side, value investors will stick on that final point (Veeva's profit) and note that, with Veeva spending heavily on research and development and pushing aside nonrecurring business in favor of subscription-based business, its near-term profit results will suffer. Given the stock's forward P/E of 128 and price-to-sales ratio of 21, it would certainly seem value investors are right to question Veeva's current valuation.

So where does the balance lie? My guess would be somewhere in the middle.

In the plus column, Veeva is growing its recurring business at a remarkable rate, which will help ensure stable cash flow in the latter half of this decade. In addition, there's a growing need from life sciences and biopharmaceutical providers to improve operating efficiency and reduce costs through the use of CRM and cloud-based software solutions.

In the negatives column, it'll be years before Veeva's profits grow in any meaningful way while the company is focused on expansion and subscription revenue growth. We may not see this forward P/E dip below 50 for another three or four years. To me, this means the real value of Veeva is probably a bit lower than where it's trading now, but that it also deserves a sizable premium to traditional health care software developers. Over the short term, this means short-sellers may indeed have a slight edge.

Uh-oh, spaghetti-O!
While Veeva is overflowing with potential avenues of growth, Campbell Soup is finding the going tough since reporting dismal first-quarter results for fiscal 2014 in November.

Although Campbell hasn't had much in the way of bad news that would spur short-sellers to jump aboard over the past month, the negative tone from its quarterly report could easily be the reason short interest rose by 22% in the latter half of December. For the quarter, Campbell reported a 2% decrease in revenue, a 4% drop in organic sales, and a 21% decline in earnings per share, to $0.66, missing Wall Street's consensus by a mile. To add insult to injury, Campbell also lowered its full-year forecast to account for the slow start and an inventory shift for many of its retailers.

If there was a bright spot over the past couple of months, it was the Bloomberg report that Warren Buffett and Berkshire Hathaway (BRK.B -0.68%) may be eyeing Campbell after purchasing Heinz. Berkshire Hathaway and its CEO make a living by purchasing seemingly "boring" companies that are capable of generating strong cash flow in any economic environment. Food companies like Campbell are still vulnerable to rising food costs, but they sell a basic necessity product that often does well no matter what.

Like Veeva, there are clear positives and negatives. Ultimately, though, this comes down to catalysts, and I'm just failing to see any for Campbell over the near term. While that's bad news for sending Campbell's share price much higher, it's also bad news for short-sellers who are looking for news that might push shares lower. With a beta of just 0.45, short-sellers would probably be best served looking elsewhere.

MEDNAX's beanstalk
Last, but far from least, we have MEDNAX, a U.S.-based medical group that focuses on neonatal, maternal-fetal, and pediatric physician services.

It's not hard to understand why short-sellers have been skeptical of rallies in hospital and insurer stocks lately given how poor Obamacare health exchange enrollments were through their first two months. Weaker than expected enrollment coupled with millions of Americans losing their health insurance because their policies didn't meet tougher benefits requirements established under the Patient Protection and Affordable Care Act is the perfect recipe to move short-sellers into these stocks.

But MEDNAX isn't your typical medical group. With a unique focus on neonatal and pediatric care it's able to use its niche physician network and pricing power to drive growth throughout the country. In MEDNAX's third quarter, it reported a 17% increase in revenue, net income, and cash flow from operations. Furthermore, a growing number of Medicaid and CHIP-eligible patients are having a positive reimbursement effect on MEDNAX's bottom line, to the tune of $0.06 per share in the third quarter.

With Obamacare enrollments only recently kicking into high gear and Medicaid-eligible patients flocking to this new health-care reform law, it looks as if MEDNAX could have a couple of years of double-digit growth hidden up its sleeve. It's not a company I'd recommend short-sellers bet against at the moment.