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 and 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 sold short and see if traders are blowing smoke or if their worry could have some merit.

Company

Short Percentage Increase, 
Aug. 15 to Aug. 31

Short Shares as a Percentage of Float

Kraft Foods (NYS: KFT)

32.2%

1.2%

Under Armour (NYS: UA)

52.5%

7.7%

Rite Aid (NYS: RAD)

9.2%

10.4%

Mac 'n' squeeze
Short-sellers should be ashamed of themselves for even thinking about betting against the macaroni-and-cheese icon. Despite a jump of 5 million shares currently held short, I feel now is the wrong time to bet against one of America's favorite companies.

For starters, Kraft recently announced that it was going to split into two separate businesses: an international snack segment and a North American grocery business. Much like oil giant ConocoPhillips, which is splitting in the hopes of unlocking shareholder value, Kraft will be aiming to simplify operations while also increasing shareholder value. Investors seeking rapid growth can tap into the international segment, while dividend investors can enjoy the stability of the North American operations.

Second, and most important, Kraft is still growing at a steady rate. Rising costs haven't eaten into Kraft's bottom line excessively, which makes its current valuation seem quite reasonable. Short-sellers could get squeezed out of this one if they aren't careful.

We must protect this stock
Under Armour football commercials will tell you to "protect your house." I'm telling longs they need to protect their stock from a rising tide of short-sellers.

Based on its recent quarterly report, Under Armour doesn't have too much to worry about. Revenue rose by 42%, to $291 million, and net income rose by 78%. Perhaps most impressive was the direct-to-consumer segment, which saw an 81% increase in revenue. CEO Kevin Plank added to the bullish trend by outlining an aggressive plan to double revenue by 2013 and also increased revenue and earnings guidance. So what could possibly be wrong here?

The 250-basis-point gross margin drop is the concern. The company saw less than favorable retail margins during the quarter, even with a 300-basis-point drop in selling, general, and administrative expenses. While I'm not crying wolf here, all that good news can very easily be canceled out if margins don't improve. Consider this stock on watch.

Rite Aid, wrong stock
The vultures are circling, and it appears Rite Aid is dinner. The once-profitable drugstore is a shadow of its former self and is now just a glaring target for Walgreen (NYS: WAG) and CVS Caremark (NYS: CVS) , which are waiting in the wings to pick up the scraps.

Since 2008, Rite Aid has struggled to eke out any operating income at all. Debt continues to be a major issue for Rite Aid, and despite having briefly returned to being cash-flow-positive before a setback in its most recent quarter, it seems to be a case of too little, too late. Short-sellers now hold 67 million shares; I expect this figure will keep moving higher. Perhaps it's Rite Aid that needs the first aid aisle.

Foolish roundup
Here's a surprise -- earnings stability matters more than a recognizable name. Rite Aid may have once been great, but Kraft and perhaps Under Armour have the real staying power when it comes to the bottom line.

What's your take on these three companies? Are the short-sellers blowing smoke or do their cases have merit? Share your thoughts in the comments section below and consider adding Kraft Foods, Under Armour, and Rite Aid to your watchlist to keep up on the latest news from each company.

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 nameTMFUltraLong. The Motley Fool owns shares of Under Armour.Motley Fool newsletter serviceshave recommended buying shares of Under Armour. 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 wants more mac 'n' cheese, please!

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