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.

Will these two heads be better than one?
Household names in Big Pharma may be garnering all the attention when it comes to merger and acquisition rumors, but there's also a heated buyout battle between Valeant Pharmaceuticals and Allergan (NYSE: AGN).

In April, Valeant offered to buy the similar-sized Allergan for $48.30 per share in cash and 0.83 shares of Valeant common stock for each share of Allergan. Based on Friday's close this works out to roughly $157.17, or about $4.13 below where Allergan ended last week. In response to the offer, Allergan quickly installed a "poison pill" -- a shareholders' rights plan ensuring that no single entity is able to acquire more than 10% of Allergan's outstanding stock. And rumor has it the company is also prepared to formally reject Valeant's buyout offer.

Valeant's strategy in attempting to scoop up Allergan is consistent with its intention of becoming a top-five global drugmaker by the end of 2016. However, this decision gives me pause.

Valeant's $8.7 billion purchase of privately held Bausch & Lomb made plenty of sense to me, as Bausch & Lomb had entrenched itself in the rapidly growing market of ophthalmic care. But I wonder what Allergan would bring to the table at this offer price.

Consider for a moment that Allergan's once-prized wet aged-related macular degeneration drug DARPin disappointed in midstage studies. Meanwhile, its nearly $1 billion acquisition of MAP Pharmaceuticals has yielded zero rewards, with experimental inhaled migraine medication Levadex being rejected twice by the Food and Drug Administration due to manufacturing concerns. Allergan's existing products such as Botox and Restasis are growing nicely, but a finite patent period will ultimately curb their growth. Investors need to see some sign of strength from Allergan's pipeline, and lately it has just not been there.

My suggestion, therefore, is that until Valeant packs up its bags and leaves Allergan alone, short-sellers may indeed feast upon its shares.

Rolling the dice
Investors have apparently bet on red when it comes to casino and resort operator Las Vegas Sands, which saw its short interest spike nearly 55% at the end of April.

"Why bet against Las Vegas Sands?" you ask? Well, weaker first-quarter GDP caused by the polar vortex engulfing much of the U.S. could leave consumers with less disposable cash. This could mean bad news for tourist getaways such as Las Vegas and might negatively impact Sands' bottom line. Add in the fact that China's GDP growth has slowed over the past three years, and you have a potential recipe for slower earnings growth.

The Venetian Macau. Source: Las Vegas Sands.

What actually happened, though, was another Wall Street-crushing earnings performance in the first quarter thanks to impressive growth in Macau, the Chinese special administrative region and gambling hot spot. For the quarter, Las Vegas Sands produced more than $4 billion in revenue, a 21% increase over the prior-year period, as its Macau adjusted property EBITDA soared 49.1% to a record $939.8 million. Not to be outdone, EPS jumped 37%, while its dividend rose 43%, and the company repurchased 10 million shares of common stock equaling $810 million. Game, set, match, optimists! 

If this has demonstrated anything, it's that Las Vegas Sands is a mastermind when it comes to executing its global growth strategy. With a projected dividend yield of 2.7%, Las Vegas Sands should be on the radars of income investors, adding further support to its share price, while its forward P/E of 17 still seems reasonable given its low double-digit, high single-digit growth potential. As long as Sands' overseas properties continue to grow strongly as a whole there's little reason for optimists to be concerned.

The most overpriced IPO, ever?
The question has certainly been posed: Is software-as-a-service provider Castlight Health the most overpriced IPO in history?

Probably not, given that a number of dot-coms from the late 1990s and early 2000s were still in the conceptual stage of their development when they went public. At least Castlight can fall back on its Wall Street-topping first-quarter results released last week. Castlight's enterprise cloud program for health care companies helped propel revenue 339% higher year over year to $8.4 million, while adjusted gross margin expanded to 23.1% from an adjusted gross loss of 69.2% in the year-ago period.

However, short-sellers also have a point that this IPO was still grossly overpriced; and based on its loss potential over the interim, it may still be!

Despite a full-year revenue forecast that calls for $40 million to $41 million in revenue -- essentially a tripling from the previous year -- the company anticipates an adjusted loss of $1.01-$1.03 per share. All told, even with $220 million in cash, cash equivalents, and marketable securities, this cash pile is likely to be cut in half over the next six or seven quarters as Castlight focuses on expansion at the expense of profitability.

While the company's niche makes sense on paper as health-care companies look to cut costs and streamline production, until we see concrete improvements in its bottom line, I suspect this is a stock that will remain heavily short-sold.