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 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 underperformed the Russell 3000, a broad-scope market index.

A large influx of short-sellers shouldn't be a condemning 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 Increase Jan. 15 to Jan. 31

Short Shares as a % of Float

Lorillard

169.9%

4.4%

H&R Block

74.7%

4.8%

General Electric

29.4%

0.7%

Source: The Wall Street Journal.


A smoking gun?
I've long proposed that investors are playing with fire by investing in U.S.-based tobacco products producers. There are few countries around the world that have tobacco industry regulations that are strict as those found within the U.S. Yet, if you really must play with fire, Lorillard would be my company of choice.

Lorillard reported its fourth-quarter results on Wednesday and handily surpassed expectations while notching its 10th consecutive year of market-share gains. For the quarter, revenue expanded 5%, 2.9% of which came from higher cigarette volume sales and higher pricing, as well as a better than 30% market share in electronic cigarettes. Even Newport, Lorillard's premium brand, had unit volume growth of 0.7%, which is a rarity given the move away from premium brands toward discount brands as disposable income levels have tightened. 

While many may not agree, I would postulate that Lorillard's gain is coming at the pain of Altria and Reynolds American, which are both in the process of laying off workers in order to reduce costs. Altria, for instance, announced it'd be laying off 15% of its workforce in 2011 in response to declining cigarette sales. Its flagship Marlboro brand did manage a 100-basis-point year-over-year retail share gain to 42.6%, but the company has had to spend heavily on a new advertising campaign just to achieve these results. Lorillard has all of the momentum domestically and also announced a 6.5% boost to its dividend. Bet against Lorillard? I think not!

A taxing opportunity
Investors in tax preparation service and software providers are probably smart in assuming that this year's tax code changes, being a little more extensive than normal, are likely to coerce taxpayers into their stores and into buying their software even more so than in previous years. However, those same investors would be foolish to assume that the effect is going to be huge, especially for brick-and-mortar-based H&R Block.

The first point to keep in mind with H&R Block is that it lost money in three of the past four quarters. H&R Block is an extremely cyclical business that sees its peak revenue and profit generation between January and April. If you were to buy in now, you're certainly not out-maneuvering what every other investor is seeing as well.

Secondly, even with H&R Block's expansion into tax preparation software, it's light years behind Intuit with its TurboTax do-it-yourself software. Just 5% of all taxpayers still paper-file, leaving H&R Block scrambling to close underperforming brick-and-mortar locations and retrieve some of the market share lost to Intuit over the past couple of years.

Finally, where's the value? Wall Street's estimates call for sales growth of just 3% over the next year, yet H&R Block is already trading at 15 times this year's estimates. I'd say this is a stock that short-sellers should be drooling over.

A steal of a deal?
I always have to wonder what's going on in the minds of short-sellers when they willingly bet against conglomerate General Electric. Outside of its finance arm, which is nearly back to full strength again, GE is running on all cylinders and daring short-sellers to stand in its way.

Last week, GE announced that it'd be selling its remaining stake in NBC Universal to Comcast for $16.7 billion. The deal looks like a win-win for both parties, even if investors feel that Comcast got away with purchasing the remaining stake of NBC Universal on the cheap. The deal allows Comcast, which had been seeing above-average results from its stake, to realize 100% of NBC Universal's revenue. In the fourth quarter, NBCU's sales rose 4.8% and EBITDA rose 11% to $1.17 billion. Extrapolated out, Comcast paid less than four times EBITDA for NBC Universal, a veritable steal.

For GE, the added cash gives the conglomerate ample opportunities to make acquisitions as well as help fund its aggressive share repurchase plan, which will ultimately add value to shareholders by boosting EPS and making the company appear cheaper from an earnings perspective. GE's industrial organic growth shot up by 8% in its most recent quarter, and it's expected that GE will see huge demand for wind- and alternative-energy-based products over the next decade. Short-sellers, consider yourselves warned!

Foolish roundup
This week we're focusing on the continuation of trends. GE and Lorillard have been building market share and taking care of investors nicely over the past few years while H&R Block has been backpedaling and trying to regain the market share it lost to Intuit.

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.

Can the rebound in GE continue?
For GE, the recent financial crisis struck a blow, but management took advantage of the market's dip to make strategic bets in energy. If you're a GE investor, you need to understand how these bets could drive this company to become the world's infrastructure leader. At the same time, you need to be aware of the threats to GE's portfolio. To help, we're offering comprehensive coverage for investors in a premium report on General Electric, in which our industrials analyst breaks down GE's multiple businesses. You'll find reasons to buy or sell GE, and you'll receive continuing updates as major events unfold during the year. To get started, click here now.

The article Shorts Are Piling Into These Stocks. Should You Be Worried? originally appeared on Fool.com.

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. Motley Fool newsletter services have recommended buying shares of Intuit. 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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