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% of stocks -- nearly two-thirds -- 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 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 Percentage Increase March 15 to March 30

Short Shares as a Percentage of Float

Lexmark International (NYS: LXK) 42.2%8.9%
Pandora Media (NYS: P) 37.9%12.4%
Lions Gate Entertainment (NYS: LGF) 54.4%9.5%

Source: The Wall Street Journal.


Inkjet dry?
Hardware companies far and wide are trading at valuations that are as cheap as I can ever remember, including Lexmark International at just seven times forward earnings. But realistically, I have to wonder where the future growth is going to come from with Lexmark, because printers don't seem to be offering the same growth rate that they were a decade ago. Revenue has contracted in each year since 2004 except for one, and analyst forecasts look for this trend to continue at least through next year.

Lexmark is also dealing with increasing competition in the printing sector from Hewlett-Packard (NYS: HPQ) and Eastman Kodak, which are struggling to find avenues of growth and are willing to aggressively advertise their products in order to grow their business.

Short-sellers are wise to realize that when Lexmark misses on EPS, its stock tends to plummet by double-digit percentages. Being short Lexmark could have its advantages, as the company missed on EPS in two of the past four quarters.

Are you Sirius?
Oh, what a tangled web the Internet radio services weave! Pandora Media continues to generate buzz as a potential threat to Sirius XM (NAS: SIRI) -- a thought that I shared just over a year ago -- but I'm ready to abandon that mode of thinking. With Sirius finally capable of turning a profit, it appears short-sellers have wisely turned their attention to Pandora, which has yet to demonstrate that it has a long-term profit-producing business model.

First, Pandora generates about 85% of its revenue from advertising. Ad-based Internet companies largely went belly-up in the early 2000s because of the inflexibility of the ad market and the rigidity in ad pricing. Secondly, and most important, Pandora Media is paying out roughly half of its revenue in the form of royalties to music labels -- a figure that is only likely to increase as time goes on. Pandora has very little price-negotiating power despite its increasing consumer base, and that could ultimately be its downfall. The shorts know this -- and I remain on their side in this case.

Not feeling the hunger
"Buy the rumor, sell the news." We've heard this phrase countless times, but we've seen it in action recently with Lions Gate's release of TheHunger Games. The movie has so far grossed in excess of $322 million.

The concern I have with Lions Gate and TheHunger Games -- other than the cult-like teenage following the movie company has created -- is that the movie will be too much of a one-hit wonder to propel the company higher. Keep in mind that I'm not arguing against the success of The Hunger Games or the Twilight series. Instead, I'm wondering where are their other success stories beyond just these movies? The truth is Lions Gates' hits have been sporadic, as indicated by its numerous annual losses, and short-sellers have historically been wise to bet against Lions Gate when it has rallied in the past.

Foolish roundup
Just to throw you a curveball, this week I have three companies that I feel short-sellers have wisely locked onto. Each company has serious questions to answer about its long-term business plan and, until those are answered, none of them makes a particularly attractive investment.

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, and consider using the links below to add these stocks to your free and personalized watchlist to keep up on the latest news with each company.

Also, if you'd like to avoid the potential pitfalls that high short interest can bring, I suggest you download a copy of our latest special report: "The Motley Fool's Top Stock for 2012." In it, our chief investment officer gives you the skinny on a company he has dubbed the "Costco of Latin America." Best of all, this report is completely free, but only for a limited time. Don't miss out!

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, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.Try any of our Foolish newsletter servicesfree 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 adisclosure policythat never needs to be sold short.

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