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 tend to trend upward over the long term. But when you look at individual stocks, you'll find plenty that lose money over the long haul. According to hedge fund institution Blackstar Funds, between 1983 and 2006, even with dividends included, 64% of stocks underperformed the Russell 3000, a broad-scope-market index.

A large influx of short-sellers shouldn't be a condemning factor for any company, but it could be a red flag indicating that something is off. Let's look at three companies that have seen a rapid increase in the number of shares sold short and see whether traders are blowing smoke or if their worry has some merit.

Source: The Wall Street Journal.

Fail by rail?
The drilling and storage of oil is expected to be a big growth-driver in North America over the coming decades thanks to large shale discoveries in the U.S. and Canada. What investors often overlook, though, is the advantage that oil by rail could play in lessening the load on midstream pipeline companies.

The rise in oil transportation by rail isn't without its risks, however, and we're seeing those become apparent with the rapid rise in short interest in Canadian National Railway, also known as CN. CN is highly dependent on the price of West Texas Intermediate crude, as well as the spread between WTI and Brent crude. When that spread weakens, shale plays in the north Central Midwest are less likely to ship their oil to the Gulf to take advantage of higher Brent prices. Similarly, weaker oil prices can deter drillers from increasing production -- and WTI prices have mostly been hovering below $100 per barrel over the past couple of weeks.

These worries, though, seem largely overdone, and I would expect CN to continue to deliver strong results moving forward. In its most recent quarterly results, CN delivered an adjusted 13% increase in profits as carload volume increased 3% and its operating ratio improved 0.8% to 59.8%. Furthermore, to signify the strength in its cash flow CN announced that it would be repurchasing up to 15 million of its outstanding shares, which can help improve EPS by reducing the number of shares outstanding.

With the potential for huge finds in the oil sands of Canada and the U.S. heavily emphasizing domestic production, CN's future looks bright, which should give short-sellers a reason to contemplate their pessimistic bet.

King of the buggy whips
Solid market share is almost always desirable in business -- unless that market is on a steepening long-term decline.

Clear Channel Outdoor, one of the nation's largest outdoor billboard operators, is one such company that's struggling to contain weakness both domestically and abroad as businesses continue to switch from static advertising to mobile forms of advertising via the Internet and email.

In Clear Channel Outdoor's most recent quarter, we saw just how weak things have gotten. The company reported a 1% decline in year-over-year revenue as OIBDAN, a measure of margin for billboard advertisers, decreased 5% when excluding negative foreign exchange rates. Although the company is expanding its overseas digital displays, it's not proving enough, with businesses (especially in the U.S.) being hesitant to spend heavily on promotions.

Another red flag was the questionable call by Clear Channel Outdoor to take out a $2.2 billion loan in order to pay out a special dividend to its parent company, Clear Channel. The move cleared the way to lower its parent company's crushing debt liability in 2014 but does nothing for either company's mammoth debt load over the long run. Even worse, it pushed Clear Channel Outdoor beyond $4.5 billion in net debt, which effectively stymies any chance it has of making strategic moves or acquisitions.

In other words, I'm behind the short-sellers of this stock.

Too far, too fast?
It was an incredible year for the biotech sector in 2013, with the overall sector rising by approximately 50%. Many companies handily surpassed that return, including Puma Biotechnology, which shot higher by 452% on the year.

The reason Puma grew wings (and no, it wasn't because researchers had a Red Bull) was extremely positive, and surprising, results from a mid-stage clinical study involving experimental breast-cancer drug neratinib. The data from that study showed that the neratinib arm could, according to the Bayesian predictive model, be expected to deliver results superior to those delivered by the placebo in treating HER2-positive/HR-negative breast cancer. Specifically, Puma's studies noted a 94.7% probability of superiority, while also using this predictive model to forecast a 78.1% probability of superiority over a control arm utilizing Roche's Herceptin and paclitaxel.

While there's a huge market opportunity in treating breast cancer which hasn't yet been met, there's a wide variance between predictive models and actual results that optimists may not be fully accounting for at the moment. Puma's neratinib is already in phase 3 trials and being pitted head-to-head against GlaxoSmithKline's Tykerb, which will be the real test of neratinib's success. Unlike its phase 2 study which was based on predictive models, its larger phase 3 study will be based on traditional progression-free survival and overall survival methods, which is really what counts.

Now don't get me wrong, I'm not saying neratinib won't be widely successful. It may prove dissenters wrong and crush them in their tracks. Then again, I've seen optimism based on predictive models get squashed in mid and late-stage trials before, and this seems like the perfect setup for optimists to be sorely disappointed. Expect 2014 to be a transformational year one way or another for Puma.

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The article Shorts Are Piling Into These Stocks. Should You Be Worried? originally appeared on Fool.com.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. 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.The Motley Fool recommends Canadian National Railway. 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.

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