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How easy is it to identify short selling opportunities?

Looking for patterns in the most popular shorted stocks may be a regular exercise for analysts, but recent studies suggest that it is tough to find connections in the search for over-valued shares, and identify real short selling opportunities.

On 25 November, both Goldman Sachs [GS] and Bespoke Investment Group each released reports revealing the stocks that currently have the most short holdings. A prime pool traders should peruse to identify short selling opportunities then.

However, looking at them together reveals something interesting: they have nothing in common. Using different methodology ­– Bespoke analysed individual stocks in the Russell 1000 index, while Goldman Sachs looked at where and what the 833 hedge funds it surveyed were short-selling ­– the reports had no overlap.

So which stocks topped these short-selling lists, and why?

 

Bespoke Investment Group’s analysis

At the top of the list of Bespoke Investment Group’s analysis is Match Group [MTCH]. The company has been in the headlines recently following the unsavoury revelation that the company was not performing sufficient background checks on the users of its platform. The company’s stock has fallen 21% from a year-to-date peak.

Bespoke Investment Group’s analysis found that short-sellers have sold nearly 59% of the company’s float. Zacks Investment Research notes that estimates have been broadly trending downward for Match Group stock and that the magnitude of these revisions indicates a downward shift.

59%

of Match Group's shares sold by short-sellers

  

The second most heavily shorted Russell 1000 stock was customer feedback company Medallia [MDLA], which went public in June of this year. On 5 December, the company reported an above-expectations revenue increase of 27% year-on-year for the quarter ending 31 October.

Short sellers have sold more than 46% of the company’s shares. In November, Zacks Investment Research cut Medallia from a buy rating to a hold rating.

46%

of Medallia's shares sold by short-sellers

  

ADT [ADT] completed the top three, with 37.5% of its stock sold short. The security behemoth reported last month that the take-up rate for its premium home automation system had risen by 17% compared to the previous quarter and the revenue from its deal to sell its Canadian business to Telus will be used to pay a special dividend later this month.

However, at the beginning of this month Bank of America [BAC] downgraded the stock to neutral from buy. Analysts Gary Bisbee and Jay Hanna explained that while sentiment remains subdued and valuation is far from demanding, there are few catalysts for continued outperformance. While lauding the company’s efforts to invest and change its business mix, they also noted that this strategy was hurting profit growth and inhibiting the company from de-levering.

37.5%

of ADT's shares sold by short-sellers

  

They forecast no more than a slight increase in revenue at best. Meanwhile, 2020 profits and cash flow are expected to come in slightly lower year-on-year amid dilution from the Canadian asset sale, ongoing investments, and 3G radio conversion costs.

 

Goldman Sachs: what are hedge funds shorting?

There was no overlap between the companies referenced by Bespoke Investment Group and the most heavily shorted stocks as listed in the Goldman Sachs November Hedge Fund Trend Monitor report.

By far the most popular short for hedge funds in November was pharma giant Bristol-Myers Squibb [BMY], the short interest as a percentage of float cap (9%) is over double that of AbbVie [ABBV] – this, in turn, was four times more likely to be shorted than any other stock on the list.

On 4 December, Zacks Equity Research suggested Bristol-Myers Squibb is currently undervalued and that, based on various metrics and the strength of its earnings outlook, it has the appearance of a value stock. However, another analyst observed that it is now trading at just over 17 times the earnings per share recorded over the past 12 months.

AbbVie, the second-most shorted stock on Goldman Sach’s list, has had a mixed year. A recent report from the Institute for Clinical and Economic Review suggested that the company’s new (and expensive) rheumatoid arthritis drug “provides marginal clinical benefit”.

On the upside, the company’s third-quarter earnings report showed a 3% increase in revenue compared to the same period in 2018 ­– ahead of consensus analyst estimates – and adjusted earnings per share was also higher than expected.

 

 Bristol-Meyers SquibbAbbVie
Market Cap$149bn$132bn
PE ratio (TTM)18.3541.08
EPS (TTM)3.462.18
Operating Margin (TTM)29.68%41.11%

Bristol-Meyers Squibb & AbbVie share price vitals, Yahoo Finance, 17 December 2019

 

The long and short of shorting

Short selling involves selling shares you don’t own in anticipation that a stock will drop in value. This technique doesn’t just apply to stocks. Currencies, options and other asset classes can all be shorted.

Typically, short selling is associated with speculative traders looking for short-term gains, but hedge funds and other investors also short stocks to offset risk. For example, you might hold shares in one stock expecting it to gain over five years, but also short the stock to mitigate any short-term volatility – effectively having two opposing positions.

 

To find out more about how shorting works, read our guide.

Disclaimer Past performance is not a reliable indicator of future results.

CMC Markets is an execution-only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although we are not specifically prevented from dealing before providing this material, we do not seek to take advantage of the material prior to its dissemination.

CMC Markets does not endorse or offer opinion on the trading strategies used by the author. Their trading strategies do not guarantee any return and CMC Markets shall not be held responsible for any loss that you may incur, either directly or indirectly, arising from any investment based on any information contained herein.

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