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.

Clean up, aisle four
Nearly all niche proprietors face competition at one point or another, and shareholders in organic and natural grocer Whole Foods Market learned the hard way two weeks ago that being first only places a big bull's-eye on your business.

In Whole Foods' second-quarter earnings report, the company delivered record sales of $3.3 billion on a 4.5% increase in comparable-store sales (and that was with a 50-basis-point negative impact from Easter shifting to later in the year). However, net income didn't budge, with the company earning $142 million in this quarter and in the year-ago period as store costs and direct store expenses rose.

Source: Whole Foods Market. 

What's to blame? A rising wave of competition. Whole Foods has been masterful at bringing new consumers in the door and teaching them the core values of eating healthfully. However, other companies have followed suit and have been expanding like wildfire, taking some of Whole Foods' customers and forcing it to beef up its spending.

The big question now is whether short-sellers or optimists are in control. Based on the data above from the end of April, Whole Foods' short-sellers were certainly correct to doubt the company. Looking ahead, though, I'm not sure there's much downside left.

Even with a reduced full-year forecast attributed to toughening competition, Whole Foods is still projecting sales growth of 13%-14% per year through 2018, as well as 6% comparable-store sales growth. Furthermore, it anticipates that sales, EBITDA, and return on invested capital will grow at a faster pace than its square footage, proving that the company is efficiently using its space and truly understands its core customer base.  

With such a high number of Americans considered obese or overweight, I can't help but see a bright future for Whole Foods. Clearly, it's not the only answer to a healthy lifestyle, but it's the most visible leader in the organic and natural foods movement, which should translate into fairly steady growth prospects. At 22 times forward earnings, but with the possibility of 6% organic store growth, I believe the tide is once again favoring the optimists.

Bill-bored
Since the dawn of capitalism, billboard and logo-sign advertising has driven visual impressions of businesses around the U.S., helping to build their brand image and drive growth. Lamar Advertising is one such business that's looking to take advantage of the need to create visual impressions with its nationwide network of static and digital billboards.

Source: Zombieite, Flickr.

But, as you can tell from the short interest data above, skeptics are beginning to build -- and I believe with good reason. My concern is that billboard advertisers are living about two decades in the past. Static billboards may have inexpensive maintenance costs, but they're much tougher to change than digital billboards, which can be managed with the flick of a switch, and for which companies can charge higher rates based on the time of day. On the flip side, digital billboards have the drawback of being costly to convert from the static type. This is the dreaded catch-22 of billboard operators.

The biggest concern for Lamar Advertising, though, is that consumers are moving their purchases online in increasing numbers, which could weigh on the company's business over the long run. Even countering with the digital boards may not make much difference if businesses see more success catering to consumers through social media and other sources of online advertising.

In addition, over the past decade Lamar Advertising hasn't earned more than $46 million in net income in any single year, which, based on its current shares outstanding, wouldn't get its P/E below 100. In the first quarter, for example, its top line grew by just 3%, with pro forma adjusted EBITDA up a minuscule 0.4%. Overall, though, Lamar lost money once again during the quarter, even if it did reduce its net loss by more than 50%. 

Given the company's dated advertising model and a decisive shift toward online viewership, I'd suggest short-sellers have a smart play here in Lamar.

Source: Tarikgore1, Flickr.

Farming for clues?
The $64,000 question this week is whether the Zynga turnaround will take shape before we're too old to do anything about it. With a number of key leadership changes the social game maker has attempted to revamp its image and has, in the process, shed quite a few jobs and cut costs to bring the company back toward profitability.

We saw the beginnings of this turnaround taking shape in the first quarter, in which Zynga reported sequential quarterly growth in bookings, adjusted EBITDA, and audience and mobile bookings for the first time in two years. Zynga Poker, for instance, grew its audience by 19% and achieved sequential booking growth for the first time in seven quarters.

But is this really the new Zynga or merely a departure from the Zynga we've been accustomed to (namely the company that has erratic growth patterns and which has difficult getting consumers to consistently spend money)?

I'd suggest this is more of the same for Zynga, which has turned to purchasing growth rather than creating an innovative engine from within. Zynga's $527 million purchased of privately held NaturalMotion in January, combined with its 15% workforce haircut, signals that it has lost focus to some degree and is grasping for straws to discover anything that will work.

Look at the real year-over-year comparisons, rather than the sequential quarterly results, shows a company whose revenue plummeted by more than $95 million and which reported a $61.2 million loss compared to a $4.1 million profit in the prior-year period. Zynga is giving off all the signs of a sinking ship, which would make me inclined to believe that short-sellers will be victorious in the end.