Three Stocks Seeing High Short Interest, But Two Are Presenting Value

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It always puzzles me when shorts surround themselves around certain stocks that have seemingly strong fundamental performance. At the same time, there are stocks where a short position is completely logical. With that being said, I am looking at three stocks that have seen a recent increase in short activity, two of which are illogical and one that looks to be a great short investment.

Two Stocks with High Short Interest That Don’t Make Sense

During the two week period ending Dec. 15, Teradata (NYSE: TDC) saw its short interest rise 65% according to Credit Suisse. The news was reported on Dec. 27 and caused shares to fall another 2.66%, adding to its 20% fall over the last three months. Much of its recent loss has come in light of Amazon’s new cloud based services, a somewhat weak Q3 earning report, and concerns regarding industry market share.  

Teradata operates in a segment that is growing rapidly, and provides products that are growing just as fast. The company is expected to see continued top line growth and bottom line growth of near 50% in 2013. The stock is now trading at just 19.45 times next year’s earnings, which isn’t cheap but is attractive considering the growth of “big data.” The company recently tried to instill confidence by issuing a $300 million buyback program. Hopefully, this buyback program can create support for the stock, but either way, the short interest does seem somewhat odd considering its growth and valuation.

Mellanox (NASDAQ: MLNX) may have been hit the hardest in the past few weeks, with a 30% rise in short interest and strong institutional selling. Investors have remained fearful of the company’s long-term prospects, including competition from Intel and changes with upper management. Furthermore, a “weak” earnings report sparked the selling pressure, which has caused Mellanox to lose 44% of its value in the last three months.

Back in September, Mellanox was trading with a P/E ratio of 60 and a price/sales of 11.0! Now, its metrics are cut in half, and all of its recent decline was sparked after the company posted a quarter where revenue grew 130% and its bottom line grew over 900%! Therefore, with a forward P/E ratio of 13.96 I can not see why or how an investor could logically short this stock, not at these levels.

Excessive Valuation Makes ServiceNow an Enticing Short Option

The final company to see a drastic rise in short interest is ServiceNow (NYSE: NOW), a company that operates in the same space and has a short interest of 38.5%. The company’s valuation has declined by more than 25% in the last three months, following a quarter where earnings were somewhat disappointing to investors. The company’s guidance was slightly below expectations and it also saw both its bookings and backlog reflect weakness for the immediate future.

ServiceNow varies from Mellanox and Teradata because of valuation. While Teradata and Mellanox trade at valuations that are appropriate for their growth, ServiceNow trades with a forward P/E ratio of 2,952 and a price/sales of 16.54, which is significantly more expensive than the overvalued social media company LinkedIn. This is a company that is growing at less than 100% year-over-year and would need several years of 100% sales growth just to be fairly valued. Therefore, I believe that placing a bet that the stock will fall further is a good call, one that makes sense.

Conclusion

When a company trades with an excessive valuation, such as ServiceNow, it must perform to perfection with zero signs of weakness in order to maintain optimism. Earlier this year, Mellanox fell into this category, but has since fallen when these signs began to appear. But now, in the case of both Mellanox and Teradata, the strong selling pressure has created value and opportunity for investors. Meanwhile ServiceNow’s expectations remain high and its risk for large loss is much greater than the other two companies that we discussed. Of course there is more due diligence that should be performed, but it’s not hard to see which of these companies have the greatest likelihood of trading higher versus the one that should be shorted. 


BrianNichols is long MLNX. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Teradata. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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