<< 11 stocks that say ‘short me’ >> ( they are a little late, but maybe not )
money.msn.com
By Michael Brush 6/6
When hefty valuations and a moribund market make all stocks look like possible shorts, downward earnings revisions are one key to finding prime targets.
Given the nagging concerns about potential terrorist attacks, accounting fraud and the speed of the economic recovery -- all issues that won’t be resolved soon -- chances are good the markets may be stuck in a trading range at best. Car? Home? Home equity?
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Buy-and-hold investors may simply hunker down to wait things out. But more aggressive investors are scouting for stocks to short in any upcoming rallies inside this trading range. Investors short stocks by borrowing shares and selling them. They're expecting the stock to sink so they’ll be able to buy it back at a lower price to “cover” the short and pocket the difference. The risk in shorting a stock is that it may not fall in price, and that risk increases substantially if you borrow money to short a stock.
One way to produce a list of short candidates is to look for stocks with the worst downward earnings-estimate revisions, a sign that fundamentals are deteriorating. Then, among those, select the companies with the highest valuations compared with their peers. This is a sign that any rallies in these already-pricey stocks will reverse.
Not surprisingly, potential shorts that come up using this approach include some of the better-known tech stocks from the bubble days, including Juniper Networks (JNPR, news, msgs), Tellabs (TLAB, news, msgs), F5 Networks (FFIV, news, msgs), Foundry Networks (FDRY, news, msgs), Computer Associates (CA, news, msgs) and Netegrity (NETE, news, msgs). One retailer scores high: Guess? (GES, news, msgs). And JetBlue (JBLU, news, msgs) deserves a mention because of an ominous sign from one of its underwriters, even though it doesn’t have poor earnings estimate revisions.
Why tech tops the list
Valuations remain high for several tech companies because many diehard bulls are still in love with the sector. Yet survey after survey of tech spenders inside Corporate America shows they are cutting back spending for the year, as their firms scramble to cut costs. Tech suppliers are left to compete for business by lowering prices, which eats into profit margins.
“I think almost all technology is a trade here,” says Tim Ghriskey, of Ghriskey Capital in Greenwich, Conn. “I don’t see these stocks as investments right now. Given the volatility of them you can make substantial money if you go long and short at the correct time.”
“I think that is right because we see pockets of substantial overvaluation,” Ralph Heffelman, president and founder of International Capital Management, a Dallas hedge fund. Merrill Lynch technology strategist Steven Milunovich, for example, likes to track the relationship between technology’s overall market cap and the contribution technology makes to the gross domestic product. At 29%, this ratio has fallen from bubble day highs of 73%. But it’s still twice the historic average of 14%.
It’s true that tech stocks are cyclical, which means they do better during times of economic growth. So shorting them coming out of a recession -- like right now -- is dangerous. What’s more, they’ve cut back on costs a lot themselves. So any uptick in spending on their products will have an even greater impact on earnings than before.
But you may get plenty of warning. “Businesses aren’t pulling the trigger on spending despite the fact that GDP looks better,” says Bill Miller, co-portfolio manager of the Gartmore Total Return Fund (GTISX). “Many people think we still need a quarter or two more of improved profitability before businesses buy into the strength that the economists are seeing.” This suggests companies won’t open up the tech spigot until the end of this year at the earliest. “We certainly do not expect tech stocks as a whole to have dramatic moves over the next six months or more,” agrees Heffelman.
Software stocks still spendy
Survey after survey by sell-side brokerage houses has concluded that spending on software is moribund and unlikely to improve this year. “While further downside to 2002 budgets appears limited, bare-bones spending plans look to be fixed for the year with little chance of upside,” says Goldman Sachs’ software analyst Rick Sherlund. “For the most part we believe the group will be trading-range bound this summer,” agrees Christopher C. Shilakes of Merrill Lynch. Lehman Brothers and UBS Warburg have also recently slashed earnings estimates on software companies across the board.
Despite the writing on the wall, some software stocks still carry high price-earnings multiples. The best ones to consider shorting in rallies are those with other issues, such as ongoing accounting investigations, that could put a cap on any upside. Computer Associates, with a forward P/E of over 100, is one example. The Securities and Exchange Commission is investigating the company’s accounting. “No one wants to own issue stocks like these,” says John LaForge, of the Phoenix-Hollister fund company. “It is just a tough, tough ball game.” Another candidate is RSA Security (RSAS, news, msgs), which has a P/E of nearly 300. The company, which produces security software that manages access to corporate databases and Web sites, is under investigation by the SEC for the way it disclosed some accounting changes.
Two other software companies with high forward P/E ratios in the 70-80 range (but no known accounting investigations) are Netegrity, which makes software that controls access to e-commerce sites, and Informatica (INFA, news, msgs), which makes data warehousing and analytical software.
Telecom and networking equipment providers
Price competition among the phone companies, combined with a glut of long-haul capacity, continues to spell trouble for the telecom equipment providers. Long-distance pricing has been coming down because providers such as Sprint (FON, news, msgs), and AT&T (T, news, msgs) face competition from regional Bell companies like Verizon (VZ, news, msgs) and BellSouth (BLS, news, msgs). In wireless, even though demand is strong, price wars are hurting margins because there are too many providers. “The trend is for the service providers to cut capital spending, and they are really nowhere near done,” says Bill Rouhana, the former chief executive and founder of Winstar, a fixed wireless company. “So I don’t see any near-term relief for the equipment providers.”
Yet many of them still sport big P/E ratios. High-speed router maker Juniper Networks, for example, has a forward P/E of 144 -- a valuation which should decline because of competition in that space, says Arun Ratnam, analyst with International Capital Management. Three others with rich P/E ratios in the 50-60 range despite big cuts to earnings estimates are: Tellabs, Foundry, and Anaren Microwave (ANEN, news, msgs), which makes wireless transmission equipment.
Another suspect in networking is F5 Networks, whose products help companies relieve Internet congestion by routing traffic to the most appropriate servers. Despite the gloomy outlook for corporate tech budgets, F5 still carries a forward P/E of around 250.
Consumer-related companies
This may be the time to sell even the best retailing stocks. Typically they’re weak during the summer months. And the consumer may soon start to fade. So it’s no surprise some hedge fund managers are starting to short successful retail stocks with high P/E ratios. “Consumer stocks are lugging around P/E multiples the likes of which we haven’t seen in a while,” says an analyst at one hedge fund.
Even casual apparel maker Guess? has a P/E of 33, which is high for retailers, despite the fact that earnings estimates have been cut sharply because of a weaker outlook. Sell-side analysts suggest a floor for the stock may be book value of around $4 per share. The stock currently trades at about $6.25.
Finally, business is strong at discount airliner JetBlue, which recently came public. But UBS Warburg, one of the banks that helped it come public, recently started covering the company with a “reduce” rating and a price target of 38, or well below where it currently trades in the mid-40s. You don’t see that often from banks that helped bring a company public. It’s a sign JetBlue shares, which have among the highest valuations in the airline group, are vulnerable.
The problem with shorting these stocks
Obviously, it would have been smarter to short these tech stocks two years ago, before they plunged 60% to 90% in value. Those kinds of gains aren’t likely now. Instead, expect more modest trading gains of 10% to 20% from shorting these stocks in rallies now. <DOH>
Next, many of these companies are already heavily shorted. (To look up short interest data, go to the Web sites of the various stock exchanges.)
A big short interest can actually be a sign a stock is headed higher. Good news, for example, can spark a short squeeze: Too many shorts trying to cover at once can drive a stock price up dramatically. <doh>
Besides, if the current market gloominess were just the flip side of the exuberance that carried the Nasdaq above 5,000 two years ago, this would be a bad time to go short. “Shorting in a market like this one is tricky, tricky business,” says LaForge. “It is the same as buying when Nasdaq was at 4,000. The risk is that someone comes out and says things are getting better next quarter. Then you are in trouble.”
At the time of publication, Michael Brush did not own or control shares in any of the companies listed in this column. |
