Watch For The Bear Trap: Hedge Funds Short Selling Well Performing Stocks
With a few notable exceptions, heavily shorted stocks have gone up faster than some without bearish sentiments.
For many reasons, short selling stocks is tricky. Even institutions who have been following a company for years don't have nearly as much information as those on the inside.
Beyond that, when you bet on a company to essentially fail, you know there are hundreds or thousands of employees who are doing their darndest to prove you wrong. Finally, short selling can also paradoxically send a stock price up, even when the company isn't adding any value.
While some call short selling predatory, others argue it's an essential part of getting market prices close to fair value.
- Short selling occurs when you borrow shares, usually from a broker, and sell them.
- When the company's stock goes down, you buy back the shares at a discounted price and return them.
- This is called short covering – all this extra activity can send up a share price.
- And if too many people try to cover at the same time, it inflates demand for the shorted shares.
- This is called a short squeeze��� – and it can send a price through the roof.
Quartz recently published "19 charts that will restore your faith in the global economy," which suggest that, from multiple vantage points, the global economy is beginning to improve considerably. Bolstered by a number of encouraging trends out of Japan and Western Europe – where even Spain is starting to slog out of its financial crisis – global markets are calming.
It's not exactly an ideal situation for short sellers. In fact, in a strange phenomenon this year, the most heavily shorted stocks have gone up more on average than the stock market as a whole.
So we decided to look for ways to get in on the action.
A spike in short selling generally causes pessimism about a company. However, with so many short calls going through the roof – think Tesla (TSLA) and Netflix (NFLX) – we decided that some of these stocks might be worth a second look.
We searched for stocks that institutions are short selling, that also appear to be doing well by multiple indicators.
Our screen was limited to stocks that have added to their sales and as well as earnings per share (EPS), quarter over quarter.
Then, since "the market" is already "down" on these companies, we looked for other signs of undervaluation, such as low P/E ratios and debt.
We were left with four companies on our list.
Click on the interactive chart below to see data over time.
Do you see investment opportunities in short sold stocks? Use the list below as a starting point for your own analysis.