If you want to avoid stocks that can torpedo your portfolio, take a look at the companies targeted by short sellers. Highlights in August include the banks, gold miners, Shopify Inc. and a maker of face masks, Alpha Pro Tech Ltd.
A good predictor of underperformance in a stock is a large or rising short position. As Professor Haiyan Jiang and co-authors conclude in their recent review of the academic literature on short selling (forthcoming in the European Accounting Review), short sellers have a “superior capability in processing publicly available information [and frequently] an information advantage from the acquisition of private information ….”
The short position in the iShares S&P/TSX 60 exchange-traded fund (ETF) is perhaps the best gauge of bearish bets on the overall direction of Canadian stocks. In August, it dropped dramatically from 119-million to 90-million shares, as many short sellers moved to unwind their positions in the face of the relentless upward trend in the market since mid-March. But with market valuations stretched, one might suspect the short sellers could be back when upward momentum wanes.
At the company level, bearish bets are on the rise in some sectors. In August, banks and precious-metal miners had some of the largest monthly jumps in short sales by dollar value, according to data-analytics firm S3 Partners. They also had some of the largest increases over the past three months – the top four companies being: Barrick Gold Corp., TD Bank, Royal Bank of Canada and Bank of Nova Scotia.
As for stocks with the largest decreases in short interest, Shopify Inc. is a notable case. It experienced a one-month drop of nearly $300 million, for an 11.5-per cent reduction in short interest. Its three-month drop of $1.1 billion, a 48 per cent reduction, was the biggest of all companies.
With Shopify’s stock rocketing upward this year, many short sellers have cut losses and bought back shares. This massive wave of short covering has been a big factor in pushing up the share price to even more extreme valuations.
Shopify is trading above 50 times revenues without earnings growth within a very competitive market, observes Veritas Investment Research head, Anthony Scilipoti, in a recent interview on the Uncommon Sense Investor website. His advisory has a sell recommendation on the company.
Ever since the COVID 19 pandemic erupted, Alpha Pro Tech has topped the list of companies whose short positions are a large percentage of their float. Its line of protective apparel and face masks is very much needed at this time and the stock has quadrupled since March. However, that elevated price is vulnerable to other sources of supply emerging and a subsiding of the pandemic.
Appearing on the table of the most expensive stocks to borrow are many of the usual microcap suspects, including Electrovaya Inc., Titan Medical Inc., Resverlogix Corp. and Mega Uranium Ltd. Back-of-the-envelope calculations indicate that the costs to borrow these four stocks have averaged 20 to 45 per cent annually over the past two years that the Short sales on the TSX column have tracked them.
Some brokers will forward at least half of the loan payments to clients who are long the stocks, and the high borrow fees can occasionally trigger short squeezes that send the stock upward for a time. Thus, rather than avoid the microcap stocks in the sights of short sellers, speculators who roll the dice in the penny-stock space might consider going long on some for a trade.
Larry MacDonald is an author, journalist and economist. He can be reached at firstname.lastname@example.org