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 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 underperformed the Russell 3000, a broad-scope market index.
A large influx of short-sellers shouldn't be a condemning 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 number of shares sold short and see whether traders are blowing smoke or if their worry has some merit.
Short Increase May 15 to May 31
Short Shares as a % of Float
'Tis Noble(r) in the mind to suffer?
Sorry to break out the cheesy Shakespeare reference, but it certainly appears that short-sellers are setting themselves up for some suffering by increasing their bets against independent oil and gas company Noble Energy, which has assets in the natural-gas-heavy Marcellus Shale, the Gulf of Mexico, off the coast of Israel, and offshore of Equatorial Guinea.
I can somewhat understand the reasoning behind pessimists piling into Noble, given the weakness we've seen in global markets. If China's GDP growth remains well below its historical 30-year average, and the Fed pares back its stimulus in the U.S., we could see a serious slowdown in oil demand, which could depress prices.
Then again, Noble's assets are well diversified, as it is oil-rich in many of its deepwater and offshore ventures, and gas-heavy in its onshore U.S. shale deposits. This diversity allows for cash flow stability thanks to high margins from oil production while also giving it the opportunity to take advantage of the coming natural gas revolution with the Obama administration pushing for an energy-independent America.
Noble Energy's valuation should also be a cause of concern for short-sellers. The company is relatively inexpensive compared to its peers at just 14 times next year's earnings and seven times cash flow. Its dividend yield of 0.9% could stand to be a bit higher if it wants to attract longer-term investors, but outside of this small flaw, I see no reason that short-sellers should be this pessimistic about Noble.
Can you dig it?
Mining is a lot like the biotech industry in that making the discovery is just half the battle. For biotechs, the other half of the battle comes from successfully launching a drug. For mining companies, it's all about whether or not they can cost-effectively open a mine, especially with metal prices falling across the board. Thus has been the plight for gold miner Kinross Gold, which recently had to abandon yet another project because of a mixture of costs and greedy foreign governments.
Last year, for instance, Kinross pushed back its expansion of the Tasiast mine in Mauritania because of excessive labor and build-out costs. Not surprisingly, in late April of this year, Kinross again pushed back the expansion of Tasiast, which it estimated would cost $2.7 billion, especially in light of falling gold prices. But if you think this is a scenario unique to Kinross, you'd be dead wrong.
Newmont Mining , one of the world's largest gold miners that has a big presence in Canada, where mining costs are often significantly lower, was forced to take a $1.61 billion writedown on its Hope Bay mine because of falling gold costs and unjustifiable expenses despite the presence of retrievable gold. These assets are useless if they can't be retrieved, and have, in some cases, been sold to bolster miners' cash positions.
Things got even worse for Kinross last week, when, as my Foolish colleague Rich Duprey notes, it had no choice but to walk away from its Fruta del Norte project in Ecuador because the government demanded too large a production stake to make a build-out feasible.
While I do like gold miners, Kinross could be one of the weakest of the bunch, with many of its expansion projects being put on hold. The short-sellers may have a perfectly good reason to be pessimistic here.
Can you say no to Flo?
Following last week's big tumble, skittish investors have turned to the insurance sector, among others, for safety. Insurance is a pure money-making business, even when you include the occasional catastrophe that ransacks insurers' balance sheets. Insurers utilize catastrophes as ample justification to boost premiums to the point where they can recoup the cash balance needed to pay members out when the next round of catastrophe claims are filed. As such, insurers will always find a way to remain profitable over the long run. That doesn't, however, mean they can't get ahead of themselves.
It's been a great couple of years for the automotive industry, with sales booming in the U.S. and overseas. Ford , for example, had its May U.S. sales jump 14% with its best-selling F-Series pickups seeing nearly a 31% uptick in unit sales. But to expect auto sales to grow at such a rapid clip with the possibility of lending rates rising (low lending rates drive the financing that helps facilitate car sales) as the Fed pares back its bond-buying program known as QE3 just isn't reasonable. Even Ford understands that China and India could be its major growth areas for the future.
That could portend bad news for Progressive, one of the nation's largest auto insurers. If lending rates rise, auto sales are almost certain to fall, negating a lot of the new premiums Progressive would be expecting to underwrite. Let's not also forget that auto insurance is among the most competitive of all insurance industries, meaning Progressive spends quite a bit of its operating cash flow on marketing and advertising.
In short, there's only so far that Flo, the Progressive spokeswoman, can take this company, and I feel it may have hit its peak -- at least in the interim.
This week's theme is all about reasonable expectations. I feel it's pretty reasonable to expect Noble Energy to outperform its peers given its relatively cheap valuation while Kinross Gold and Progressive have much to prove if they hope to even maintain their current valuations.
What's your take on these three stocks? Do short-sellers have these stocks pegged, or are they blowing smoke? Share your thoughts in the comments section below.
3 more for the road
With American markets reaching new highs, investors and pundits alike are skeptical about future growth. They shouldn't be. Many global regions are still stuck in neutral, and their resurgence could result in windfall profits for select companies. A recent Motley Fool report, "3 Strong Buys for a Global Economic Recovery" outlines three companies that could take off when the global economy gains steam. Click here to read the full report!
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 owns shares of, and recommends, Ford. It also recommends Progressive. 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.