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 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.


Short Percentage Increase Feb. 29 to March 15

Short Shares as a Percentage of Float




American Water Works (NYS: AWK)



MEMC Electronic Materials (NYS: WFR)



Source: The Wall Street Journal.

A clean revolution
With natural gas prices at a decade low, activist groups and electricity-generating utilities are making the move from coal to cleaner-burning natural gas. Does this mean it's time to pack up your bags from the coal sector for good? Let's just say that I feel you're a fool (small "f") if you do!

Coal continues to be the primary fuel for nearly half of all electricity generation in the United States. A perfect storm of low natural gas prices and weakness in China's previously impervious economy has everyone concerned that coal stocks are yesteryear's news, but I'm here to tell you otherwise. Coal stocks are cheaper now than I can ever recall. One of my personal favorites, Arch Coal (NYS: ACI) , is trading well below book value and has a dividend yielding just above 4%.

But if there is an overvalued coal company, it's CONSOL Energy at more than two times book value and 12 times forward earnings. I can't say I appreciate its 1.5% yield, either, with a handful of better options out there. I like the sector, but I can't say I care much for CONSOL's reduced valuation.

Life's essentials
I know in reality that a 0.5% short position is nominal, but who in their right mind bets against one of life's necessary resources, water?

American Water Works, a "Mid Cap to Rule Them All" selection of mine, has been under pressure recently for comments made during its recent quarterly report that new regulations might cap what it can charge customers, which would ultimately cut its revenue. As of now, this is pure speculation, and the company reported a 16% jump in profits in the fourth quarter on higher revenue and reduced expenses. With a yield of 2.7%, American Water Works offers one of the most stable dividends in the water utility sector based on its low payout ratio of 51%. It may not seem like it, but water is also a scarce resource and, in my eyes, there's very little profit to be had betting against a necessary and scarce resource.

The sun setting on solar?
Investing in the solar sector has become so warped recently that a victory could be something as simple as your stock falling only 2% in a day. A combination of Germany's announcing that it was going to cut solar subsidies by up to 30% and a 50% drop in solar prices in the past year has solar panels producers like First Solar (NAS: FSLR) struggling, as was evident by its latest quarterly report.

But it's also doing a number on polysilicon and solar module manufacturers like MEMC Electronic. Polysilicon prices have fallen through the floor over the past few years, and demand has completely dried up except for a select few Chinese solar companies ramping up production despite the falling panel prices. According to Yahoo! Finance, 23 analysts' EPS estimates for fiscal 2012 range from a $0.77 loss to a profit of $0.50. In short, no one has a clue where demand is headed, and I feel short-sellers have every right to be skeptical of future production at these levels.

Foolish roundup
This week, it really comes down to whether you're brave enough to bet against necessity items; I'm clearly not. Not surprisingly, valuation is also a big factor as to whether shorting a stock makes sense, as in CONSOL's case.

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 thisarticle was published Fool contributor Sean Williams has no material interest in any companies mentioned in this article. All this talk of "wafers" suddenly has him craving food. 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.Motley Fool newsletter services have recommended buying shares of First Solar. 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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