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 have tended to trend up over the long term. But when you look at individual stocks, you'll find plenty of stocks that lose money over the long haul. According to hedge fund institution Blackstar Funds, even with dividends included, between 1983 and 2006, 64% of stocks -- nearly two-thirds -- underperformed the Russell 3000, a broad-scope market index.

A large influx of short-sellers shouldn't be a damning factor to any company, but it could be a red flag from traders that something may not be as cut-and-dried as it appears. Let's look at three companies that have seen a rapid increase in the amount of shares sold short and see whether traders are blowing smoke or if their worry has some merit.

Company

Short Percentage Increase March 30 to April 13

Short Shares as a Percentage of Float

Banco Santander (NYS: STD) 214% 0.6%
MetroPCS Communications (NYS: PCS) 79.7% 2.4%
Pentair (NYS: PNR) 57.2% 8.7%

Sources: The Wall Street Journal and Yahoo! Finance.


Checks and imbalances
As Spain's woes deepen, the outlook for big Spanish bank Banco Santander continues to dim. With Spanish unemployment creeping up on an unimaginable 25% and the country's debt being downgraded yet again last week, it's very plausible that Banco Santander will see its business adversely affected.

For starters, Banco Santander has paid out a trailing dividend yield of about 13% over the past year, which at least to me seems unsustainable. It seems only reasonable to expect the bank to slash its dividend to conserve cash in order to meet regulators' liquidity requirements. It also wouldn't be the first time we've seen a high-yielding Spanish company cut its dividend in order to conserve cash. Telefonica (NYS: TEF) cut its annual dividend by 14% just a few months ago. But there's a big difference between the near-guaranteed cash flow of telecom and lending operations. The austerity measures in Spain will almost assuredly impact Santander's business in a negative way. I feel short-sellers have every right to be skeptical of the stock, even at these depressed levels.

I'll gladly pay you Tuesday for some spectrum today
You know things are going wrong when the struggling Sprint Nextel doesn't want anything to do with you. MetroPCS is struggling as a second-tier phone company behind giants AT&T and Verizon, and will either need to purchase spectrum to get a competitive edge or rapidly improve upon its fumbling business model.

In its recently ended first quarter, MetroPCS reported a 63% drop in net income as margins sank and subscribership remained weak. For the quarter, the company netted just shy of 132,000 customers, its weakest gain in the first quarter in years. Also at the heart of MetroPCS' weakness has been its inability to get its customers to upgrade to smartphones. The company has been pushing heavy discounts to coerce customers to make the switch now before it falls too far behind its competitors. Between rising costs and weakening subscriber trends, it looks like the optimists are up to their ears in wishful thinking. Short-sellers own this stock -- at least for now.

A match made on water
Two heads really are better than one! Last month, Pentair announced an all-stock merger with Tyco International's (NYS: TYC) flow control business segment, which should give the company greater access to emerging markets and vastly reduce costs. Short-sellers don't seem to be 100% sold on the deal, but count me among those pretty excited about the combination.

Pentair noted that while there will be about $230 million in one-time merger-related costs associated with the deal over the next one to two years (perhaps the only selling point for the bearish thesis), the combination should add $0.40 per share to the bottom line in 2013 and could propel annual EPS past $5 per share by 2015. I know we're looking deep into the future, but considering that Pentair produced just $2.41 in EPS in fiscal 2011, we're talking a doubling in profits over the course of just four years. Pentair isn't a dividend slouch either. You can collect a 2% yield while the company works out its merger-related kinks. I think short-sellers would be wise to avoid Pentair.

Foolish roundup
For once, I have no grandiose deeper message, just a reminder to pay attention to the macro and micro trends in a company's quarterly report. Banco Santander and MetroPCS are giving off plenty of warning signs, while Pentair's merger-related comments clearly signaled a bullish turn.

What's your take on these three stocks? Do the short-sellers have these stocks pegged, or are they blowing smoke? Share your thoughts in the comments section below, and consider using the links below to add these stocks to your free and personalized watchlist to keep up on the latest news with each company.

Also, if you'd like to avoid the potential pitfalls that high short interest can bring, I suggest you download a copy of our latest special report: "The Motley Fool's Top Stock for 2012." In it, our chief investment officer gives you the skinny on a company he has dubbed the "Costco of Latin America." Best of all, this report is completely free, but only for a limited time. Don't miss out!

At the time this article was published Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.Try any of our Foolish newsletter services free for 30 days. We Fools don't 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 that never needs to be sold short.

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