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Shorting Coinstar: The Worst Way to Play a Market Decline

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By Lou Basenese :

Last Friday, I revealed that investor sentiment has hit new lows .

But merely feeling glum about the stock market is one thing. Actually doing something about the situation can totally change the landscape.

And that's exactly what's happening.

The latest reports from the New York Stock Exchange and Nasdaq reveal that investors increased their bearish bets during the last two weeks of May.

Specifically, short interest on the NYSE rose by 2.17%, with a 3.41% climb on the Nasdaq - big moves for a two-week period.

Remember, investors who sell stocks short seek to profit from falling share prices. They borrow shares, then sell them to a buyer right away, hoping to buy them back later at a cheaper price to pocket the difference. It's essentially a long stock purchase in reverse.

Here's what confounds me about the latest short interest data, though: Investors are betting against companies with rock-solid fundamentals.

Like this one, for example…

Profiting From Pocket Change

Based on short interest as a percentage of the float (i.e. shares available for trading), Coinstar Inc. (Nasdaq: CSTR) is the second most shorted stock in the entire S&P 1500 index (which includes all stocks in the S&P400, 500 and 600 indexes).

A staggering 39% of Coinstar's available shares are currently shorted, compared to just 6.3% for the average stock in the S&P 1500 index.

Yet the company boasts some of the strongest growth fundamentals in the market.

Consumers dump their change into a sorting basket, the machine
counts it and then spits out a voucher, which is redeemed for cash
at the nearest register.

You're probably familiar with one of Coinstar's two business segments - the company's network of 19,000 coin-counting machines in supermarkets and other retail outlets across North America.

Consumers dump their change into a sorting basket, the machine counts it and then spits out a voucher, which is redeemed for cash at the nearest register.

It's not free, of course. Coinstar charges a 9.8% convenience fee in the United States and 11.9% in Canada. However, consumers can avoid the fee by converting their coins into gift certificates instead of cash at the machines. And they're redeemable at popular retailers like Amazon (Nasdaq: AMZN), Lowe's ( LOW ), JCPenney ( JCP ), Starbucks (Nasdaq: SBUX) and iTunes ( AAPL ).

Movie Night at Redbox

While Coinstar's change-counting machines are pretty familiar to most people, what you might not know is that Coinstar also operates the largest network of self-service DVD rental kiosks - Redbox.

Instead of shelling out $12 for a movie ticket, consumers can pay $1 a night at any of the company's 30,000 Redbox kiosks located at retail outlets across the country.

Each machine holds 200 titles (with multiple copies) at a time, almost all of which were released in the last six months.

And let me tell you… the business of pocket change and cheap thrills pays!

Strong… and Getting Stronger

In the last quarter, Coinstar's revenue blasted 31% higher - to $424 million. As a result, profit jumped by 53% and margins fattened. Coinstar also managed to increase its market share.

Such enviable results aren't a fluke, either.

In the coming year, analysts expect Coinstar to grow its sales and earnings by 25.7% and 48.3%, respectively.

And according to my analysis, that's conservative, given its continued market penetration and growth initiatives. For instance…

  • It just landed a deal to install its coin-counting machines in the 1,400 Safeway stores in the United States and Canada.
  • This month, the company's also adding video game rentals to its Redbox kiosks.

So why in the world would investors bet against such a solid company? Especially since its business would prosper, even if the economy sours again.

Given that the underlying business fundamentals are so strong, investors must be betting against the stock because it's obscenely overpriced - just like OpenTable (Nasdaq: OPEN) was back in February - right?

Wrong!

When Bears Become Bozos

On a historical basis, Coinstar is reasonably priced, trading at about 30 times earnings. That's hardly frothy. Not when you consider that its profits are expected to grow three times as much as the average stock in the S&P 500 this year.

And on a forward-looking basis, the massive amount of short interest is even more confusing. Coinstar trades for just 13 times forward earnings, right in line with the average for the S&P 500 index.

Bottom line: If you're feeling bearish because of the underwhelming macro-economic picture - and decide to act on it - stick to shorting fundamentally flawed companies, not strong ones like Coinstar.

And if you want truly actionable advice, consider going long Coinstar. As the company continues to post impressive results, shares could see a massive short squeeze, as all the foolish bears rush for the exits and buy to cover their positions.

See also Top Buy and Sell Ideas Based on Last Week's Biggest Gainers (Part 1) on seekingalpha.com

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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