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

Company

Short Percentage Increase, Sept. 15 to Sept. 30

Shorts Shares as a Percentage of Float

Avery Dennison (NYS: AVY) 44%3%
Lithia Motors (NYS: LAD) 61.5%15.5%
Barnes & Noble (NYS: BKS) 17%30.6%

Source: The Wall Street Journal.

Paper cut
Worries in the retail sector are beginning to trickle down to the manufacturing sector, and we can point to Avery Dennison as an example. Back in July, the retail branding and paper products provider updated its previous guidance by lowering profit expectations. The company noted weaker spending trends in the retail segment, pointing to higher raw material prices and inflation as the primary driver for the reduction in its volume and profit forecast.

Fast-forward three months later and it's no surprise that short-sellers seem to be stocking up on Avery Dennison's stock. In that time, analyst estimates for the just-ended quarter have fallen by nearly 30% and even rival 3M (NYS: MMM) has seen its profit projections recently reduced by analysts. Avery Dennison's 3.6% yield is definitely enticing, but with preliminary October consumer sentiment figures hitting their lowest levels since 1980, I'd be very weary of retailers and their manufacturing suppliers right now.

Out of gas
Quick: Think of a sector that has greatly outperformed almost every other sector since the 2009 lows. If you said automotive, you've clearly cheated, because even I wouldn't have guessed that. Lithia Motors, owner and operator of automotive retailers, recently upped its previous earnings guidance on the heels of a 30% jump in revenue. Things appear to be falling Lithia's way right now, and the company even reinstated its quarterly dividend last year. Still, it might be a bit early for the optimists to declare a full-fledged victory.

Also during that second-quarter report, CEO Sid DeBoer stated that "the outlook for the remainder of 2011 remains volatile." The reasoning he gave stemmed from volatile gas prices, high unemployment levels, and continued supply disruptions from Japan. Add to this Lithia's $631 million in debt and you have enough question marks to merit caution as short-sellers set their high-beams on Lithia.

Brick & mortared
Note to Barnes & Noble: While it may be a smart idea to recruit Borders' previous customers, let's not forget that you're pandering to a group of people who helped lead a company into eventual liquidation.

Over the past year, Barnes & Noble has missed earnings expectations all four quarters and now has to contend with Amazon.com's (NAS: AMZN) aggressively priced-to-move Kindle. The Nook has been a revenue generator for Barnes & Noble, but it's still not enough to get the company back to profitability or even remotely compete with Amazon on a larger scale. With more than 30% of the float currently held short, it could only be a matter of time before Barnes & Noble becomes a dinosaur.

Foolish roundup
Sometimes the shorts are blowing smoke, and sometimes they aren't. This week, all three companies have some serious questions to address, and until they are answered, short-sellers could rule the roost.

What's your take -- do the shorts have these stocks pegged or are they blowing smoke? Share your thoughts in the comments section below and consider adding Avery Dennison, Lithia Motors, and Barnes & Noble to your free and personalized watchlist to keep up on the latest news with each company.

At the time this article was published Fool contributor Sean Williams has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong and on Twitter, where he goes by @TMFUltraLong. Motley Fool newsletter services have recommended buying shares of Amazon.com and 3M. Try any of our Foolish newsletter services free 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 a disclosure policy that never needs to be sold short.

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