In the late 1990s, a furiousbull market led to a great deal of
pain among professional short sellers. In fact, several
high-profileinvestment firms that actively focused onshort selling
were forced to close as clients demanded theirmoney back because of
considerable trading losses.
Ever since, short sellers have learned to get out of the way of
a risingmarket and reflexively draw down their positions whenever
the market is rallying sharply higher. And that's just what's
happening right now.
In a recent article
, Bloomberg News noted that less than 6% ofshares are currently
held in short accounts, which is the lowest level since 2007 and
roughly half the level seen in 2008 and 2009. Perversely, as these
short sellers have sought to close out theirbearish positions,
they've added buying fuel to this market, creating deeper pain for
the remaining short sellers who chose to stay engaged.
Yet this massive unwinding of short positions, known as a "short
squeeze ," creates an unusual opening for investors. If short
sellers thought that certainstocks wereovervalued to begin with,
these stocks may be even more overvalued than before asshort
covering gave them an artificial boost. And assuming the short
thesis is still intact, these stocks are likely ripe for a fresh
short position now that the massive short covering trend has
started tofade . (In the past three reporting periods, total short
interest in the market has finally stabilized, indicating that the
massive short covering phase is over.)
Here are two heavily shorted stocks that have been "squeezed"
higher in this bull market but still possess considerable potential
1. HomeAway.com (Nasdaq:
This operator of websites catering to home-based lodging completed
anIPO in the summer of 2011 and initially traded above $40.
However, by late 2012, investors grew concerned that annualsales
growth would slow from above 30% (as had been the case every year
from 2007 through 2011) to less than half that rate. Indeed, sales
growth cooled to about 20% in 2012, where it is likely to remain in
2013 and 2014 as well (according to consensus forecasts) and
Goldman Sachs projects itwill be at less than 15% by 2015. In
effect, this is an impressivebusiness model that may be moving
closer tomarket saturation .
If that's the case, gauging this company's level of
profitability becomes crucial as it approachesmaturity and, by that
score, shares are starting to look quite frothy. Goldman Sachs
expects HomeAway to generate $134 million inEBITDA by 2015, yet the
company now sports an
of about $2.5 billion. That means shares trade at nearly 19 times
projected 2015 EBITDA, which is quite rich for a company on the
cusp of slowing growth. (As an alternative take, Morgan Stanley is
morebullish on this business model and expects EBITDA to hit $154
million by 2015, which still yields a hefty 16 times EBITDA [to
enterprise value]multiple .)
Meanwhile, short sellers have been abandoning their positions,
as the short interest levels have dropped by roughly 30% during the
past three months. And that has fueled thisstock 's impressive
upward move, which as noted, has now left valuations quite
2. Hewlett-Packard (NYSE:
It's no secret that this hardware and software titan has lost its
way in recent years. The company pulled off a series of
growth-inducing acquisitions during the past five years, though
fiscal (October) 2012revenue of $120 billion was just 2% higher
than fiscal 2008 revenue. On an organicbasis , this company's top
line is shrinking. Of much greater concern is the steady fall
infree cash flow , which is never a good sign for a company with
nearly $30 billion inlong-term debt .
Hewlett-Packard's Shrinking Free Cash Flow
The fact thatanalysts expect HP's revenue base to shrink further
in coming years means more pressure on free cash flow.
Still, shares have doubled in value since mid-November (adding a
hefty $22 billion inmarket value ) on hopes that free cash flow
trends can reverse course. Although the company formally
anticipated free cash flow to fall to just $5 billion this year,
Morgan Stanley thinks the figure will rebound to $6.7 billion. But
here's the problem with that analysis: $800 million of that amount
will come from a one-time reduction inworking capital , while
another $500 million will come from major cut to capital spending,
which is hardly the right move for a company in need of long-term
Still, short sellers can't fight a bullish tape, and in the two
weeks ended March 15, they covered roughly 6 million shares that
were held short. For investors looking for fresh short-selling
ideas, HP's rally has counter-intuitively set up the nextshort sale
Risks to Consider:
If the market keeps rising, the short covering may continue,
helping these stocks to move still higher.
Action to Take -->
Although HomeAway and Hewlett-Packard have been clearbeneficiaries
of the massivewave of short covering, many other stocks have as
well. That makes this a good time to keep an eye on short interest
levels in any stocks that have made a strong upward move in 2013
and short them if you think they're headed for acorrection .
The most recent short interest data were released on March 28
(covering the period ended March 15), and new data are released in
the middle and end of every month. You can find this data at the
Journal, as well as the
New York Stock
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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