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

Quiksilver

67.2%

9%

Constellation Brands 

59.9%

3%

Noble

55.6%

2%

Source: The Wall Street Journal.


Headed for a wipeout?
The surf may be up, but investors could be headed for a wipeout at surf-and-skate apparel retailer Quiksilver. Shares of Quiksilver have tripled since its lows of last summer as the company has changed CEOs, cut expenses, beefed up marketing, and introduced new apparel styles in its stores. Unfortunately, the holiday season wasn't very kind to action-sports retailers, which should necessitate caution from shareholders going forward.

The long struggling Pacific Sunwear , which is a direct competitor to the surf-and-skate clothing that Quiksilver offers, reported a 1% increase in its fiscal fourth-quarter sales in January, but noted that its peak sales occurred during its highest levels of promotional activity -- clearly not what PacSun wanted or expected. I expect much of the same from Quiksilver, which has had to pinch pennies and reduce prices in order to keep customers coming into the store.

Another disconcerting factor is Quiksilver's reliance on the U.S. and European markets. Although Asia demonstrated sales growth of 13% in the fourth quarter, this high-growth region accounts for just 15% of total sales. With U.S. retail sales growth expected to take a hit from the end of the payroll tax holiday and Europe's sales expected to recede further from austerity measures, I'd give short-sellers a clean bill of health to short away.

This liquor is quicker
Shareholders of alcohol producer Constellation Brands are still feeling the buzz of its meteoric 37% rise two weeks ago after announcing that it had agreed to purchase its remaining interests of Grupo Modelo's Piedras Negras brewery, and all U.S. rights, for $2.9 billion.

The original deal that necessitated this purchase on the cheap by Constellation was a purchase of Grupo Modelo by Anheuser-Busch InBev . Constellation had a working interest in the existing Piedras Negras plant, but a lawsuit filed by U.S. regulators to stop the merger based on the fact that it wouldn't give Anheuser-Busch enough competition and would discourage innovation nearly killed the original deal. Constellation's $2.9 billion purchase will allow it to expand its U.S. presence for a very reasonable price and will allow Anheuser-Busch to proceed with its purchase of the remaining pieces of Grupo Modelo.

Constellation may seem a bit pricey at 15 times forward earnings following the announcement of the deal, but the sheer market share it could gain from this purchase more than negates its near-term price. Short-sellers have already been burned once and I wouldn't suggest a continued downside bet with momentum on Constellation's side.

If you drill it, they will come
Since the Gulf of Mexico oil spill in 2010, ultra-deep offshore oil and gas drillers have received a bad rap and a minimal valuation relative to their historical averages. Noble, an offshore drilling contractor, is one such company, valued at less than eight times forward earnings. Sometimes these low valuations are deserved, while other times they appear to be irrationally cheap. In the case of Noble, I'm going to err on the side of the latter.

To begin with, much of Noble's earnings inconsistency in recent quarters has to do with the downtime associated with introducing new drilling rigs into the fold. Removing these few hiccups from the equation would produce higher dayrate fees and stable to rising rig utilizations.

It's also worth noting that Noble has a done a fantastic job of locking in its contracts well in advance. Seventy-four percent of the company's operating rig days are already under contract in 2013 with about 50% spoken for in 2014. Noble's backlog in 2012 also rose $600 million to $14.3 billion. With contracts lined up and energy prices remaining stable, Noble's outlook appears bright. Barring a complete collapse in oil prices or another Gulf of Mexico moratorium, I'd consider Noble to be quite inexpensive here.

Foolish roundup
This week it's all about standing in front of long-term momentum. In the case of Noble, with plenty of deepwater oil discoveries being uncovered, and Constellation, with its soon-to-be increased U.S. market share, short-sellers appear to be playing with fire. As for Quiksilver, short-sellers appear to have accurately diagnosed its lack of growth as a genuine concern.

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.

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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. 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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