Shorts Are Piling Into These Stocks. Should You Be Worried?

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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 1983-2006 64% (nearly two-thirds) of stocks 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 take a look at three companies that have seen a rapid increase in the amount of shares currently sold short and see if traders are blowing smoke or if their worry could have some merit.

Company

Short Percentage Increase Since July 15

Short Shares as a Percentage of Float

ConocoPhillips (NYS: COP)

31.7%

1.4%

Gap (NYS: GPS)

9.7%

8.0%

Medifast (NYS: MED)

27%

37.3%

Source: The Wall Street Journal.

ConocoPhillips
Traders have a perfectly good reason to be cautious about the price of oil, especially with an economic slowdown looming. The memory of oil's somersault from $147 per barrel down to the mid-$30s in less than one year is still fresh in many traders' minds. But for bears that have increased their short stake in Conoco by 4.3 million shares since July 15, the negative news has been few scarce.

Just three weeks prior, Conoco reported its second-quarter results, which easily topped analyst estimates. Conoco is benefiting from higher price realizations as well as better refining margins -- not to mention the buzz associated with splitting its upstream business from the downstream refining business. Conoco is a regular guest on my dividend champion list, having rewarded shareholders with nearly 14% annual growth in its payout over the past decade. Suffice it to say, I feel traders are barking up the wrong tree by betting against Conoco.

Gap
To be fair, Gap's problems right now seem to be endemic to much of the apparel sector. Aeropostale (NYS: ARO) and Talbots (NYS: TLB) are two names which have had a hard time hitting the mark recently. But each company has specific troubles of their own to contend with. For Gap, these include adjusting to rising costs and rejuvenating a stale brand name.

All hope isn't lost for Gap shareholders, but there isn't much for them to cheer about. In May, the company drastically lowered its full-year outlook and just a few weeks later outlined plans to close approximately 200 stores. Closing underperforming stores is the first step in cutting costs to maintain profitability, but at some point, investors are going to want to see a return to growth. Now valued at less than 10 times forward earnings, its valuation appears enticing, but the jury is still out on Gap.

Medifast
On the surface, this weight management and diet products company looks like the next great growth story. Earlier this month, Medifast's second-quarter report detailed a 17% jump in year-over-year revenue on an 8% jump in earnings. But rising expenses could be Medifast's downfall and are a primary reason I feel the shorts may have this one right.

Unlike Weight Watchers (NYS: WTW) , which crushed estimates, Medifast missed the mark in part because of rising advertising expenses. Also working against Medifast is a history of fickle consumer spending habits. A lack of customer loyalty has done NutriSystem (NAS: NTRI) in on numerous occasions over the past five years. With a 27% increase in shares currently held short over the past two weeks, this looks like a big red flag.

Foolish roundup
It pays off to stick with products that are in high demand. If you want to avoid a short-seller onslaught, consider investing in companies with sound dividends and stable outlooks. Short sellers rarely flock to companies exhibiting these traits.

Are the shorts correct to bet against these companies? Share your wisdom in the comments section below and consider adding ConocoPhillips, Gap, and Medifast to your Watchlist.

At the time this article was published Fool contributorSean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLongThe Motley Fool owns shares of Gap and Aeropostale. Try any of our Foolish newsletter servicesfree for 30 days.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policythat never needs to be sold short.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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