As the market surged ever higher over the past five years,
short sellers were knocked off their game.
#-ad_banner-#Every time they targeted a seemingly overvalued
high-flier such as
, they were forced to cover their positions as these stocks
scaled new heights.
Such repeated bruisings left the short sellers gun-shy, and in
recent months, they simply steered clear of the most richly
As I noted in late March
, "short sellers are going after the major tech firms that
represent much better value."
That turned out to be unwise. Value-oriented tech stocks, such
Cisco Systems (Nasdaq:
saw big short interest spikes in recent months, but actually held
up fairly well in the recent tech stock rout. The high-flying
dot-com stocks that the shorts should have been targeting turned
out to deliver the most downside in recent sessions.
Still, it pays to track the actions of short sellers. They may
not be doing so well with their macro calls lately (such as
value-versus-growth tech) but their company-specific targets are
worth monitoring. I like to see which stocks have more than 40%
of their stock held by short sellers.
These are "crowded shorts," which means that a short squeeze
could prove to be painful. But it also means that a number of
investors smell a rat. Here's a look at three heavily shorted
|1. NQ Mobile (NYSE:
47% of shares held short
This China-based app developer has been subject to wild
swings. Shorts pounded this stock into submission six
months ago on allegations
made by research firm Muddy Waters
that NQ's executives were operating sham companies and that
stated cash balances were quite overstated.
Yet further research appeared to validate the company's
claims that it was legitimate, with real contracts in hand
and a growing list of blue-chip customers.
Shorts covered as shares rebound, but in recent weeks,
the shorts have returned as quarterly results fell well
short of expectations. That led to concerns that the recent
contract signings aren't yielding the revenues that they
should. Investors also had been expecting to hear about the
results of an internal audit that would address Muddy
Waters' allegations. Management's decision to delay any
response until the annual report is filed suggests to short
sellers that the company's books are indeed being
My take: This isn't a pure scam, as Muddy Waters
suggests. But it's a worthwhile short anyway as management
is building an unprofitable business that is unlikely to
deliver the kinds of profits that the company's backers are
|2. Walter Energy (NYSE:
53% of shares held short
There's an interesting showdown taking place in the coal
industry. Some investors,
such as my colleague Dave Goodboy
, note that thanks to China, "It is clear that coal usage
isn't going to decline anytime soon." Dave sees Peabody
Coal as a way to play this oversold commodity.
Yet looking beyond Chinese demand, coal used in
steel-making, known as metallurgical coal or "met coal," is
showing signs of a deep glut. Analysts at UBS recently
lowered their 2015 price forecast for met coal from $150
per metric ton to $130. And they note that Walter Energy,
which has a hefty 50% exposure to this market, is
especially vulnerable. (Dave's preferred pick,
Peabody Energy (NYSE:
, has just 14% exposure.)
Analysts at UBS recently cut Walters Energy to a "sell,"
with a $5 price target, representing 35% downside. Short
sellers, which have already ridden this stock down from $23
a year ago, see further weakness ahead as well.
|3. World Acceptance Corp. (Nasdaq:
44% of shares held short
|This company has been targeted by short sellers for
nearly a year, after investigative journalists at Pro
revealed a wide range of seemingly
predatory lending practices
. Short sellers predicted that these practices would
eventually attract scrutiny from regulators.
Belatedly, regulators have finally taken up the cause.
Last month, World Acceptance received a subpoena from the
federal Consumer Financial Protection Bureau (CFPB),
seeking more information about the company's operations.
It's unclear if the CFPB is targeting the company's
practices in particular or the payday lending industry in
general. (Privately held MoneyMutual is also being looked
at by the CFPB.)
World Acceptance generates eye-popping profit margins
from its customers. In fiscal 2013, the company generated
$224 million in free cash flow on a sales base of less than
$600 million. Still, regulators don't go after
consumer-facing businesses simply because they are wildly
profitable. Instead, any questions likely focus on the
clarity of terms spelled out in payday loans. In other
words, the CFPB can't stop consumers from making bad
choices, but they can stop deceptive sales practices.
At a minimum, look for a set of changes for the payday
loan industry that reduces interest rates on loans, and new
policy thresholds that make those loans harder to obtain.
Net/net: World Acceptance's profit margins have likely
peaked and are probably headed down in coming years, which
could be bad news for a stock that is still up nearly 300%
over the past five years.
Risks to Consider:
As noted earlier, these shorts are so crowded that any good
news could push them well higher.
Action to Take -->
Two of these three stocks profiled may be engaged in dubious
business practices, which is always very appealing to short
sellers. Although all of these stocks have moved down from recent
peaks, short sellers appear to be correct in anticipating further
downside in coming months.