Lorillard Inc. (LO), H&R Block (HRB): 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.

Lorillard Inc. (NYSE:LO)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 amount of shares sold short and see whether traders are blowing smoke, or if their worry has some merit.

Company Short Increase Jan. 15 to Jan. 31 Short Shares as a % of Float
Lorillard Inc. (NYSE:LO) 169.9% 4.4%
H&R Block (NYSE:HRB) 74.7% 4.8%
General Electric (NYSE:GE) 29.4% 0.7%

Source: The Wall Street Journal.

A smoking gun?
I’ve long proposed that investors are playing with fire by investing in U.S.-based tobacco products producers. There are few countries around the world that have tobacco industry regulations that are strict as those found within the U.S. Yet, if you really must play with fire, Lorillard would be my company of choice.

Lorillard Inc. (NYSE:LO) reported its fourth-quarter results on Wednesday and handily surpassed expectations while notching its 10th consecutive year of market-share gains. For the quarter, revenue expanded 5%, 2.9% of which came from higher cigarette volume sales and higher pricing, as well as a better than 30% market share in electronic cigarettes. Even Newport, Lorillard’s premium brand, had unit volume growth of 0.7%, which is a rarity given the move away from premium brands toward discount brands as disposable income levels have tightened.

While many may not agree, I would postulate that Lorillard’s gain is coming at the pain of Altria Group, Inc. (NYSE:MO) and Reynolds American, Inc. (NYSE:RAI), which are both in the process of laying off workers in order to reduce costs. Altria, for instance, announced it’d be laying off 15% of its workforce in 2011 in response to declining cigarette sales. Its flagship Marlboro brand did manage a 100-basis-point year-over-year retail share gain to 42.6%, but the company has had to spend heavily on a new advertising campaign just to achieve these results. Lorillard has all of the momentum domestically and also announced a 6.5% boost to its dividend. Bet against Lorillard? I think not!

A taxing opportunity
Investors in tax preparation service and software providers are probably smart in assuming that this year’s tax code changes, being a little more extensive than normal, are likely to coerce taxpayers into their stores and into buying their software even more so than in previous years. However, those same investors would be foolish to assume that the effect is going to be huge, especially for brick-and-mortar-based H&R Block (NYSE:HRB).

The first point to keep in mind with H&R Block is that it lost money in three of the past four quarters. H&R Block is an extremely cyclical business that sees its peak revenue and profit generation between January and April. If you were to buy in now, you’re certainly not out-maneuvering what every other investor is seeing as well.

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