The art of short-selling is inextricably tied to the direction
of the
market
. If the market has sold off for a number of sessions, then it's
risky to short stocks. This is because a reversal from oversold
conditions can push many stocks higher and propel heavily-shorted
stocks at an even faster pace as short sellers cover their
positions.
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The converse is also true. A market that has been moving upward for
an extended period actually sets up a favorable entry point for
investors looking to short a stock. Other short sellers may have
already been shaken out in the market rebound, and if the market
reverses itself from a recent uptrend, then short sellers become
emboldened anew to re-visit their favorite targets, creating fresh
selling pressure in heavily-shorted stocks.
To my mind, the set up for short-sellers is looking better. The
recent upward trend, which has seen the S&P 500 tack on more
than 100 points since early June, doesn't have much more room to
run, in my view. In early August,
I warned
that a series of challenges are ahead, and the higher the market
goes, the greater the chance that these headwinds will have to
wreak havoc.
This is a time for booking profits -- and looking at stocks to
short.
Though I typically give an occasional look at some of the most
heavily-shorted stocks by the size of their short position, I am
looking at short candidates by another gauge today. Specifically, I
am looking at short ideas among the stocks that have very large
short positions in relation to their trading
float
. A fresh set of short interest data has just been released, and
here's what popped up on my radar.
The For-Profit Schools
It's no coincidence that
Strayer Education (Nasdaq: STRA)
,
ITT Educational Services (
ESI
)
and
Bridgepoint Education (
BPI
)
have 31%, 49% and 48% of their tradable
shares
in the hands of short-sellers. (The trading float is smaller than
shares outstanding
because it doesn't include shares that are closely held by
management or major shareholders.)
These operators of for-profit schools have already seen their
shares pummeled in the past few years, but short sellers are
betting there is even more pain to come. The most obvious challenge
comes from Washington, where Congress remains dubious of the value
proposition these schools
offer
. A key factor behind the enrollment at these schools is the
ability for students to get government guarantees on their student
loans. If Congress decides to simply stop any federal loan
backstops for these for-profit schools, then these schools could
see their enrollment drop even further.
The tough
economy
is also a factor for short sellers. Graduates from these schools
are having a hard time landing jobs in this still-tough
job market
and that news may be spreading to friends and colleagues that had
been contemplating enrolling themselves. These schools are all
expected to see enrollment (i.e. sales) fall at a high single-digit
or low double-digit pace this year, though analysts expect to see
smaller drops in revenue (or even a modest gain for Bridgepoint) in
2013. But short sellers are betting that this industry is nowhere
close to stabilizing.
Another Housing Pullback?
The housing market is showing tangible signs of life. Prices for
used homes have begun to rise in some markets and foot traffic into
realtor
's offices is also on the rise. Many
Wall Street
analysts think they've spotted a trend and that builders of new
homes will see improvements in 2013 and perhaps a full-fledged
robust rebound by 2014.
Of course, those views were formulated this past spring when the
economy showed more vigor. Now the economy is slowing a bit, and
some are wondering if it's a bit too soon for a rush back into
housing stocks. Make no mistake: if the U.S. economy is weak as we
head into 2013, it will be virtually impossible for the housing
sector to deliver the growth that some anticipate.
At least that's the view of short sellers. They currently
control roughly 41% of the float of home builder
KB Home (
KBH
)
. They may be focusing on the
balance sheet
, which carries more than $1.5 billion in debt. Management knows it
must generate improving results to either lower that
debt load
or at least get bankers to help roll over debt as it comes due.
Goldman Sachs, which rates the stock as "Neutral," notes that "at
>75%
net debt
to capital, the issue of recapitalizing the balance sheet still
remains a concern, in our view."
Analysts at Citigroup think KB Home may just be the proverbial
worst house in the neighborhood: "Investors remain concerned that
KBH is running low on economically viable lots, that its new
mortgage
partner relationship may not be picking up momentum quickly enough
to restore order growth, and that growth and
operating leverage
may continue to lag peers." Their $8
price target
represents roughly 25% downside.
Risks to Consider:
A rising market often leads short sellers to cover their
positions, which could fuel quick upside for these heavily-shorted
stocks.
Action to Take -->
Even as you seek out stocks with robust potential upside, you also
need to commit time to finding
overvalued
stocks. A portfolio that is sprinkled with a few short positions
can help blunt the pain of a falling market.
-- 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.