Don Dorsey: Some shorting tips from the Motley Fool.
At The Motley Fool, we look for shorts among small-cap highflyers that have, in our Foolish esteem, risen out of control. Way out of control. "Momentum investors" -- people who buy certain stocks primarily because they're hot -- drive up some prices to stratospheric levels, which is easier to do to small-cap companies. The slightest failure to fulfill such grand expectations can send their shares crashing lower. So then these companies have to perform perfectly to justify their share price..
The second reason we like to short big winners is that in most instances, their Big Move is behind them. Even if the Market does well, a drastically overpriced stock will at best rise maybe another 10-20%. If the Market is flat, we'd expect the stock to decline about 20%. And if the Market turns down, look out.
We use a simple measurement to determine which stocks to short. It's the Fool Ratio, and you can read about it elsewhere in our area. We're not going to waste space here elaborately summarizing the Fool Ratio. Suffice to say that the number shows the ratio between a stock's price-to-earnings ratio (P/E) and its company's growth rate. The premise is that a stock becomes fairly and fully valued when its P/E (which is reported daily in many business sections and financial papers) equals the percent of the company growth rate.
Here's our key to shorting: When a stock's P/E ratio exceeds the company growth rate by 30% or more, consider selling it short. For PEG ratio fans, that would be a PEG of 1.30 or more.
As you can see, we're not aiming to short every stock that's quadrupled over the past year; some of those may quadruple again in the next one. But we are shorting some of those quadruplers -- and triplers, and doublers -- those whose stock has run up 30% or more beyond what we consider the fair, full value. And as you might expect, the chances of those highflyers moving up much more when they're already so overvalued is small.
The significance of short interest is relative. If a company has 100 million shares outstanding and trades 6 million shares a day, a short interest of 3 million shares is probably not significant (depending on how many shares are closely held). But a short interest of 3 million for a company with 10 million shares outstanding trading only 100,000 shares a day is quite high.
>>>>I've heard the term 'days to cover' thrown around quite a bit. Does 'days to cover' have anything to do with short interest?<<<<
Yes, it does! Days to cover is a function of how many shares of a particular company have been sold short. It is calculated by dividing the number of shares sold short by the average daily trading volume.
When you short a stock, you want the days to cover to be low, say around 7 days or so. This will make the shares less subject to a short squeeze, the nightmare of shorters in which someone starts buying up the shares and driving up the share price. This induces shorters to buy back their shares, which also drives up the price! A short days to cover means the short interest can be eliminated quickly, preventing a short squeeze from working very well.
Also, a lengthy days to cover means that many people have already sold short the stock, making a further decline less likely.
Cube's fundamentals don't coincide with the shorting tips put forth by the Motley Fool thus therefore I think Cube then becomes a risky short candidate. It's my opinion that one should consider shorting a stock that is extended to the upper limits of it's trading range rather then near the bottom of it's trading range.
The Asian virus, and competition I feel is already built into Cube's share price and thus the reason this stock trades in a tight trading range between 16 and the 23 area. It will take some positive news for this stock to breakout of the 23 area and likewise it will take some powerful negative news for a breakthrough at support at the 16 area. I believe this stock will trade with stagnation until the news of the day warrants a breakout at the upper end of the current trading range near 23. I perceive that currently the street has a wait and see attitude with Cube. They ask is this company for real, can this stock continue to meet earnings expectations? My thoughts are yes it can and will meet these expectations over time and therefore a little birdie tells me the play here is to be a buyer as Cube trades near the bottom of its trading range, not a short seller at these depressed levels.
Good luck c-ya! |
