Are Shorts Finally Leaving These Stocks?

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

For the last several years, certain stocks have remained cheap as the overwhelming presence of short sellers have made it more difficult for shares to break out. On July 4, Bespoke Investment Group’s list of the most heavily shorted S&P 500 stocks was released, showing data as of June 15. A comparison of data from late February shows that short sellers might finally be leaving some of the most heavily shorted stocks.

<table> <thead> <tr><th> <p>Company</p> </th><th> <p>Short Interest vs. Float % February 28, 2013</p> </th><th> <p>Short Interest vs. Float % June 15, 2013</p> </th><th> <p>Difference</p> </th></tr> </thead> <tbody> <tr> <td> <p><strong>J.C. Penney</strong> <span class="ticker" data-id="204134">(NYSE: <a href="">JCP</a>)</span></p> </td> <td> <p>42.64%</p> </td> <td> <p>23.60%</p> </td> <td> <p>20.04%</p> </td> </tr> <tr> <td> <p><strong>Questcor Pharmaceuticals</strong> <span class="ticker" data-id="207446">(NASDAQ: <a href="">QCOR</a>)</span></p> </td> <td> <p>49.18%</p> </td> <td> <p>32.87%</p> </td> <td> <p>16.31%</p> </td> </tr> <tr> <td> <p><strong>Spectrum Pharmaceuticals</strong> <span class="ticker" data-id="217087">(NASDAQ: <a href="">SPPI</a>)</span></p> </td> <td> <p>51.64%</p> </td> <td> <p>36.51%</p> </td> <td> <p>15.13%</p> </td> </tr> <tr> <td> <p><strong>Deckers </strong><span class="ticker" data-id="203296">(NASDAQ: <a href="">DECK</a>)</span></p> </td> <td> <p>43.19%</p> </td> <td> <p>28.90%</p> </td> <td> <p>14.29%</p> </td> </tr> <tr> <td> <p><strong>Outerwall</strong> <span class="ticker" data-id="203226">(NASDAQ: <a href="">OUTR</a>)</span></p> </td> <td> <p>52%</p> </td> <td> <p>39.69%</p> </td> <td> <p>12.31%</p> </td> </tr> </tbody> </table>

Back in late February, these five stocks were the most shorted stocks in the S&P 500, and although they are still heavily shorted, you can see the level it has dropped for each stock. The big question is whether or not this could indicate gains for these stocks, or if it has any meaning at all.

Troubled Retailer Catches Short Break

J.C. Penney has seen the largest drop in short presence during this time period, but has also seen its stock fall 23%. If the idea of being short is to predict the fall of a stock, then a 23% decline in the stock might also explain why the short presence has fallen, as short targets are reached.

What’s encouraging is that shorts have left with the fall of the stock. This is a very troubled company, one with limited cash and significant revenue declines. However, recently improved traffic levels is a cause for some celebration. But in my opinion, I still don’t see enough signs of improvement to buy in a competitive retail space.

Dust Settles and the Stock Rises

Questcor’s short presence exploded as its marketing tactics came into question with regulators and tightening insurance coverage surrounding its drug Acthar led to questions of sustainability. Personally, I really like this stock.

It is a company that’s growing at 40% year-over-year and trades at just 10 times next year’s earnings. Moreover, the company has a forward dividend yield of 2.2% and continues to buy back shares. This fact might be the reason that shorts are leaving the stock, and rightfully so.

Shorts Still Hanging On

Spectrum Pharmaceuticals’ sudden slash in guidance due to generic Fusilev pressure has led shares to post a 30% loss in 2013. Back in February, the stock was trading near $12; today it trades at $8. Thus, the short case has always been that growing sales would suddenly fall – they were right – and now after the stock’s fall these shorts have taken profits.

Considering the decline of the stock, I still find that 36.5% of its float being short is very high. This is a company that has lost 51% of its value during the last year, and there are many investors who question the marketing ability and the honesty of this company. Hence, I still think there are too many questions to get excited about any decline in short pressure.

Shifting Sentiment, Reversing Trend

Deckers has lost 50% of its value since the end of 2011, and there are many investors who have anticipated additional loss with falling shoe sales. However, Deckers has remained stable, and recent reports from Nike and Finish Line paint a bullish picture for shoe stocks, as sales look to be on the rise.

Deckers is a company that is still producing top-line growth, but is trading at just 12 times next year’s earnings at 1.2 times sales. This is a very cheap stock, and the decline in its short presence minus the presence of any real catalysts should be celebrated. Overall, it looks as though sentiment is changing for this stock, and oftentimes that can lead to large gains.

Beating Low Expectations

Outerwall, formerly Coinstar, had seen its stock fall from over $70 to $40 back in late 2012 as its RedBox movie rental growth stalled and fell behind in the streaming market. Yet, in 2013, shares had slowly but surely ticked higher, with gains of 18%.

Much of these gains came during the company’s last earnings report, where revenue continued to slow and net profit fell 58% year-over-year. While these numbers may look discouraging, this is a company that has very low expectations, and is beating those expectations. With it trading at just 12 times next year’s earnings, I think “Outerwall’ is attractive.

Final Thoughts

In my book, Taking Charge With Value Investing (McGraw-Hill, 2013), I present changing sentiment as one of the primary trends to watch and that investors seem to ignore. Investors tend to miss buying stocks at value-presenting prices but then change their outlook as a stock ticks considerably higher from its lower levels.

Just look at Groupon: much of its gains have been due to short covering, and just eight months ago there were many who expected bankruptcy as a likely outcome. Now the stock trades at 52-week highs, and aside from new leadership not that much has changed, with the exception of sentiment.

With that said, it is important not to become an investor who allows the price of a stock to dictate your outlook on a company. You need to look for the signs of changing sentiment first, and then assess whether a risk is worth a reward. In the case of these five stocks, each are without question seeing less pressure from shorts, which could be an indication of changing sentiment. 

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Brian Nichols has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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