A weak stock market sure can make short sellers look wise. So I’ll give a bit of credit to the broader market for my mostly successful set of recent short predictions.

Back in May, I highlighted five stocks that looked ripe for short sellers. Three of them have fallen sharply, more than three times as much as the S&P 500’s 14% drop.

 
Netflix (Nasdaq: NFLX) in particular has received a high-profile drubbing, though as I recently noted, the 50% haircut since late May has made this stock look a lot more appealing to go long. Yet both LinkedIn (Nasdaq: LNKD) and Rite Aid (NYSE: RAD) have performed more respectably. Are they still stocks worth shorting at this point? Let’s take a look…

#-ad_banner-#LinkedIn: Weathering the noise thus far
The fact shares of LinkedIn have hung on thus far is quite impressive. The company’s career-centric social media platform continues to pick up users, even as other social media business models start to flounder. Groupon, for example, appears to have seen its meteoric growth slow down as rival group coupon buying web sites try to gain traction. The company did itself no favors by adopting a seemingly aggressive revenue recognition policy that it recently had to reverse ahead of an imminent initial public offering (IPO).

LinkedIn’s relative strength is also impressive in light of expectations the job market is weakening (or at least not growing as many had been expecting at the time of the company’s May, 2011 IPO). LinkedIn has been increasingly seen as a rival to traditional job sites such as Monster.com (NYSE: MWW). Monster has lost half of its value since the spring, highlighting the relative resilience of LinkedIn’s stock. Lastly, the recent market pullback has been especially tough on younger companies without long track records, and IPOs surely check that box. Dealogic noted that 48 of the 76 IPOs in 2011, roughly 63%, are underwater with lower share prices today than when they went public.

The main area of interest for short sellers remains the same. This is a company worth $7.3 billion, but with just $121 million in sales and $5 million in profits in its most recent quarter. Of course, the company is growing very quickly and investors are counting on strong growth to continue for an extended period.

Let’s assume LinkedIn keeps building a global base of customers and it figures out a way to keep monetizing this base at increasing rates through its subscription programs and advertising. Using 2012 consensus forecasts already in place as a baseline, I’ve assumed sales will grow 25% annually in the period between 2013 and 2016, and earnings per share (EPS) can grow at a 40% annual pace.

 
Well, by that math, shares are valued at four times projected 2016 sales and 57 times projected 2016 profits. Simply put, it’s unclear how investors can be expecting more upside from this stock unless those lofty growth assumptions prove to be too conservative. What about competition? What about the possibility of a low-growth economy? In effect, many good things need to keep happening for LinkedIn simply to meet my numbers noted above.

As is the case with many well-regarded IPOs, investors are overlooking the risk that one of these days LinkedIn fails to deliver against quarterly expectations. This wouldn’t necessarily be a sign the business is in trouble, but it would crush the stock because it isn’t prepared for any hiccups at current valuations.

Rite Aid Hanging in there — for now
Back in May, I noted that the nation’s third-largest drugstore chain (behind CVS (NYSE: CVS) and Walgreen (NYSE: WAG)) has been hampered by a very weak balance sheet ($6 billion in debt), flat sales trends and a history of operating losses.

Yet since the late May analysis, Rite Ai has actually exceeded forecasts, losing less money than analysts had expected. Fiscal second quarter sales (ended August) actually rose 1.8% from a year ago, because the company is seeing decent traction from remodeled stores.

But the headwinds for Rite Aid are still in place, as short sellers have noted by taking up their position another 6 million shares to 67 million since I looked at this stock in May. The biggest current headwind is an income statement that can’t move into the black, despite the modest sales increase. The company had $6.27 billion in fiscal second quarter sales and $6.22 billion in combined overhead and cost of goods sales expenses. That $50 million profit simply isn’t enough to meet a $130 million quarterly interest payment on the massive debt load.

The biggest long-term headwind involves the evolving healthcare landscape. First, a number of important branded drugs are losing patent protection in 2012, as I noted in this article.

Trouble is, other drugstore chains, supermarkets and major retailers such as Wal-Mart (NYSE: WMT) and Target (NYSE: TGT) all sell many generic drugs at cost — often under $10 a prescription — in a bid to drive foot traffic. Rite Aid counts on drug sales — especially the branded kind — for whatever profits it can make. More prosaically, healthcare reimbursement changes being looked at as part of Medicare reform may reduce the number of drugs covered, shrinking the total industry pool of drug sales.

Despite its obvious woes, shares of Rite Aid continue to hang in there at around $1. But the margin of error is so small for this company that any pullback in sales or any spike in losses would bring that scary balance sheet right into focus. This stock moved below $0.25 in early 2009, and short sellers are betting it will happen again.

Risks to Consider: Short sellers are the first to hit the “buy” button when the market rebounds in order to cover their losses, so heavily-shorted stocks can get swept up in any positive market action.

Action to Take–> LinkedIn and Rite Aid have yet to generate major profits for short sellers, but a slowing economy still creates risks for these stocks, thanks to their high valuations (Linked In) and weak financial statements (Rite Aid). Each stock could lose half its value if quarterly results hit a rough patch — bad news for these companies, but good news for you if you decide to ride them down.