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Endeavour Silver Corp. (CAN) (EXK), SolarWinds Inc (SWI): Shorts Are Piling Into These Stocks. Should You Be Worried?

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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.

Company Short Increase, April 30 to May 15 Short Shares As a % of Float
SolarWinds Inc (NYSE:SWI)
48.6% 3.1%
UnitedHealth Group Inc. (NYSE:UNH)
45% 1.9%
Endeavour Silver Corp. (CAN) (NYSE:EXK)
41.8% 1.8%

Source: The Wall Street Journal.

The winds of change are blowing
It’s been a longtime target of my hand-crafted TMFULOI index, which seeks out the market’s most fundamentally overvalued companies, but cloud-based information technology and infrastructure management software firm SolarWinds Inc (NYSE:SWI) appears as if it may finally succumb to short-sellers.

SolarWinds Inc (NYSE:SWI)

As my Fool’s Rex Moore has opined previously, SolarWinds Inc (NYSE:SWI)’ razors-and-blades model is primed to set the company up for success by locking in recurring revenue and creating the impetus for upgrades as newer technologies are developed. I, however, have felt that the valuation of SolarWinds Inc (NYSE:SWI) had gotten way ahead of itself, selecting it as a strong sell candidate yet again in February with its revenue growth set to fall by about 10 percentage points, from 36% to 26% year over year.

Those fears were realized in early May, when SolarWinds Inc (NYSE:SWI) reported 22% revenue growth in the first quarter but highlighted that it’s having trouble selling new licenses. Part of this weakness could be from businesses that are being particularly cautious about expanding, given the uncertainties associated with the upcoming implementation of the Patient Protection and Affordable Care Act. It could also stem from precipitously high unemployment rates and the threat that the Federal Reserve’s paring back of its bond-buying program could stall growth. Either way you cut it, this high-growth company is losing its rapid growth rate, and that trailing P/E of 37 is now exposed for investors to see.

While I certainly give credence to Rex’s view over the long run, I think further downside may be warranted.

No Band-Aids needed, but thanks, anyway!
All of the reasons for UnitedHealth Group Inc. (NYSE:UNH) shareholders to be concerned about growth in their stock were certainly evident in the company’s first-quarter earnings report. In spite of an 11% increase in revenue to a whopping $30.3 billion and strong international enrollment, weaker patient volumes in hospitals and a huge 13% increase in medical costs actually caused earnings to fall. When added to the uncertainty surrounding the PPACA, which caps the medical loss ratio at 80%, you have what equates to a can of gasoline and short-sellers holding the match.

In actuality, though, things aren’t nearly as bad as they might appear despite these higher medical costs. I ultimately suspect that Obamacare isn’t going to be able to control premium costs from rising dramatically, as not all insurers are going to participate in each state’s exchanges. With individual insurance falling into the hands of just a few companies in each state, the prospect of higher premiums is a real possibility.

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