InvestingDaily.com

Account Information

  • My Account

    Manage all your subscriptions, update your address, email preferences and change your password.

  • Help Center

    Get answers to common service questions, ask the analyst or contact our customer service department.

  • My Stock Talk Profile

    Update your stock talk name and/or picture.



Close
FEATURED STRATEGY

Renowned Economist Paints Startling Portrait of the Future

Renowned Economist Paints Startling Portrait of the FutureRenowned economist Dr. Stephen Leeb has predicted the last 5 major market shifts. And he’s just revealed his latest prediction: “A market meltdown will wipe out the savings of millions of Americans.” In his latest report, he details which stocks will come crashing down in the coming months, as well as a select few that could double or even triple in value over the next few years. Get your copy here.

 

A High Short Interest Ratio Can Be a Warning or an Opportunity

By Jim Fink on February 26, 2013

Short sellers sell stock that they don’t own in the hopes of buying it back for a much lower price at a later date. Several studies have concluded that short selling reduces market volatility and improves liquidity. For example, Yale professor Owen Lamont wrote in Go Down Fighting: Short Sellers vs. Firms (2004):

Many of the sample firms are subsequently revealed to be fraudulent. Thus the short sellers are identifying firms having bad fundamental value. This paper has presented a rogues gallery of shady characters, ranging from Charles Keating to Adnan Khashoggi. In public battles between short sellers and firms, short sellers usually are vindicated by subsequent events. The evidence suggests that short sellers play an important role in detecting not just overpricing, but also fraud. Policy makers might want to consider making the institutional and legal environment less hostile to short sellers.

Lamont discusses examples of companies that sue short sellers for stock manipulation and found that such companies underperform the general market by 25 percent in the year following their lawsuits. His advice is to avoid companies that sue short sellers. All one has to do is look at the price performance of companies such as Solv-Ex, Overstock.com, and Biovail — now part of Valeant Pharmaceuticals (NYSE: VRX) — after they sued short sellers to conclude that short sellers were right.

Long-only stock buyers should welcome short sellers because their selling pressure lowers the price of stocks and makes them more affordable to purchase. Furthermore, when short sellers cover their positions (i.e., buy back the stock they initially sold) their buying pressure increases the value of the stocks already owned. What’s not to like?

Short Sellers are the Smart Money: Pay Attention to Short Interest Ratios

The benefit of short selling goes beyond increased trading liquidity, however. It turns out that short sellers are on average an extremely smart group of equity analysts and it pays to be aware of what they are shorting. You’ve got to be smart to survive as a short seller given all of the impediments regulators place in their way, not to mention the hostility of companies that sue them and the risk of short squeezes when lenders of stock decide they want the stock back. The Economist magazine calls the life of a short seller “nasty, brutish, and short.” But the best short sellers survive and thrive and are considered the “smart money.”

A 2004 MIT and Harvard study entitled Short Interest and Stock Returns concluded that

Our results indicate that the only class of stocks that reliably produce negative abnormal returns is that of small cap firms with extremely high short interest ratios. An investor selecting stocks for a portfolio should avoid stocks with a high short interest ratio. If an investor already owns a stock that develops sustained high short interest, the clear and strong advice is to sell the stock immediately.

“Short interest ratio” is defined as the number of shares shorted divided by the number of shares available for trading (i.e., the public float). The study found that stocks with the highest short interest ratios (99th percentile) underperformed on average by 125 basis points per month (15% per year). To qualify for the 99th percentile, the stock typically has a short interest ratio of 20% or higher. You can find the short interest for any Nasdaq stock by clicking here. The NYSE appears to charge for the most up-to-date short interest information (Bloomberg gets delayed data), but that’s okay because the study found that the negative relationship between short interest ratios and subsequent performance is strongest with Nasdaq stocks.

Stocks with the Highest Short Interest Ratios

Below is a list of the 10 stocks with a market cap of at least $250 million that have the highest short interest ratios:

Company

Shares Shorted

Public Float

Short Interest Ratio

Blythe (BTH)

6.26 million

9.93 million

63.09%

USANA Health Sciences (USNA)

4.08 million

6.53 million

62.45%

Vera Bradley (VRA)

10.51 million

20.04 million

52.42%

Spectrum Pharmaceuticals (SPPI)

27.02 million

52.12 million

51.85%

hhgregg (HGG)

6.82 million

13.39 million

50.93%

Coinstar (CSTR)

13.57 million

27.41 million

49.50%

Questcor Pharmaceuticals (QCOR)

25.93 million

53.83 million

48.16%

SodaStream International (SODA)

8.17 million

17.99 million

45.40%

American Greetings (AM)

12.03 million

26.65 million

45.14%

Ubiquiti Networks (UBNT)

3.26 million

7.37 million

44.26%

Source: Bloomberg

Short sellers aren’t always right, so some of these stocks might turn out to be good investments. But with this significant short-selling chip on their shoulders, avoidance is the easy solution for investors. Brave souls looking to profit from a short squeeze can consider buying in, but substantial due diligence research is recommended prior to pulling the trigger.

At my Roadrunner Stocks small-cap investing service, I respect high short interest ratios, but also have the confidence to go against the short-seller crowd when I feel they are wrong. When short sellers are wrong, they are really wrong and short squeezes can cause stocks to skyrocket higher. Right now, three Roadrunner recommendations have short interest ratios above 20 percent that I believe are excellent businesses with short-squeeze potential.


You might also enjoy…

 

12 Stocks Virtually Guaranteed to Go Up in 2018

You may not believe it, but I have a calendar in my hands right now that tells me the exact date and time when a few stock are practically guaranteed to go up. 

Twelve of them, in fact.

And if you were to invest in them following the simple buy and sell instructions found in this calendar…

You could be making $1,181… $11,814…. and as much as $190,916 more than by using a “buy-and-hold” strategy.

And here’s the best part…

I’m giving away a few copies of this calendar to interested investors (First come, first served).

With this calendar, you could get higher profits with less risk.

Click here to get the full story, and to claim your copy.

Stock Talk — Post a comment Comment Guidelines

Our Stock Talk section is reserved for productive dialogue pertaining to the content and portfolio recommendations of this service. We reserve the right to remove any comments we feel do not benefit other readers. If you have a general investment comment not related to this article, please post to our Stock Talk page. If you have a personal question about your subscription or need technical help, please contact our customer service team. And if you have any success stories to share with our analysts, they’re always happy to hear them. Note that we may use your kind words in our promotional materials. Thank you.

You must be logged in to post to Stock Talk OR create an account.

Create a new Investing Daily account

  • - OR -

* Investing Daily will use any information you provide in a manner consistent with our Privacy Policy. Your email address is used for account verification and will remain private.

Stock Talk

  1. avatar
    J Forsyth Reply March 7, 2013 at 4:34 PM EDT

    Does the likelihood of a short squeeze increase with the length of time the stock does not plunge precipitously after having crossed an arbitrary short interest ratio like 25% or even 50%?