Short selling — the practice of selling borrowed shares first, then buying them back later to cover your bet — got a bad name during the financial crisis as speculators bet against stocks willy nilly and made a fortune as Wall Street fell apart.
But short sellers aren’t inherently bad for the market — and they certainly aren’t always right, even when they bet against a stock.
In fact, investors who go long on a highly shorted issue can benefit from a “short squeeze” as the bears who guessed wrong have to race in and buy shares to cover their bets. After all, if you sell a stock without owning it, you have to buy it back eventually … no matter how high it has soared.
If you’re on the right side of a short trade, it can be very good. But those who ignore the stocks that short sellers are targeting might be doing so at their peril.
Because while the bears aren’t always right, it’s worth noting what they think so you can make an informed decision.
Here are seven highly shorted stocks that are in the bears’ crosshairs right now, based on Yahoo Finance data as of July 15. Short interest is reported as a percentage of the “float,” or outstanding shares that are tradable when you back out restricted stock:
Short Interest: 22.3%
2013 Return: +38.1%
Safeway (SWY) is in the thankless business of grocery retail, where margins are thin and competition is fierce. The stock peaked at over $28 a share in April before slumping 20% in a matter of days on poor Q1 earnings.
However, shares recently have been bouncing back, and better Safeway earnings for Q2 have given some momentum back to SWY.
The stock does yield 3.2% in dividends, but given the recent volatility and volume of short sellers, Safeway stock might be a tenuous buy-and-hold investment.
Short Interest: 28.5%
2013 Return: +95.2%
GameStop’s (GME) core business has seemingly been under pressure as video game sales have continued to move online — both through e-commerce sites selling titles and through downloadable content that requires no middleman merchant.
Furthermore, video gaming has moved into the mobile space with fewer console users and most gaming taking place on smartphones and tablets; Consider that recently, GME earnings slumped on a 30% decline in hardware sales.
So how could GameStop stock soar amid this environment? Well, simply, it has been poor expectations coupled with the fact that the next generation of the PlayStation from Sony (SNE) or Xbox from Microsoft (MSFT) will not include rumored features that would prevent used games from working in them.
Whether the gains stick — or whether bears increase their bet — is anyone’s guess.
GME is slated to report earnings on Aug. 22.
Short Interest: 24.4%
2013 Return: +6.5%
Frontier Communications (FTR) is a natural target for the shorts, since this telecom primarily provides voice and data connections to rural areas of the U.S.
Cable TV and landline telephone are hardly growth businesses in 2013, and the fact that Frontier has just $4.5 billion in market capitalization means it doesn’t have the scale to make that kind of business work the same way AT&T (T) or Comcast (CMCSA) does.
Shares have underperformed handily in 2013, and barring a buyout from a bigger telecommunications company, it’s clear FTR has little to offer beyond its current 8.8% dividend yield.
FTR reports tonight after the bell.
Short Interest: 25.2%
2013 Return: -32.6%
It’s not difficult to imagine why someone would be betting against JCPenney (JCP) right now. Even if you look beyond the recent rumor of a lender tapping the brakes — a rumor that was subsequently discounted, I must add — there are serious issues to this retail stock.
A spiral of same-store sales declines under the ill-advised scheming of former Apple (AAPL) retail honcho Ron Johnson have not been reversed as of yet.
And broadly, the pressures on big-box mall retail remain crushing in the age of e-commerce — with JCP struggling to find a way to connect with customers online as well as in person.
There are some times the bears are dead wrong with their short assessments, but in 2013 this has been a pretty profitable trade for the bears … and I expect it to continue to be one.
JCP is slated to report earnings Aug. 20.
Short Interest: 29.9%
2013 Return: -28.1%
Commodity stocks have been hammered by the slowdown in China, and U.S. Steel (X) has taken it on the chin, too. With slowing demand from manufacturers as well as concerns about government spending and a housing bubble in Asia, the need for steel in buildings and bridges and other goods has fallen sharply.
Furthermore, a strong dollar environment has made steel prices soft and results in thin margins for operations at U.S. Steel. The result is five losses in the past seven quarters.
Bargain hunters might start to nibble at beaten-down materials stocks in the next few months, but it’s hard to imagine any commodity stock truly breaking out before 2014. That includes this heavily shorted pick.
Short Interest: 40.3%
2013 Return: +68%
A case study in a short squeeze would be Pitney Bowes (PBI) after earnings on July 30. Apollo Global Management (APO) agreed to acquire its management-services division for $400 million to allow PBI to create a more focused mail marketing and e-commerce company, and the stock soared 25% in a matter of days.
This despite swinging to another quarterly loss.
Needless to say, the direct-mail game has fallen by the wayside in a digital age, and the competition facing PBI is fierce at a time when its total debt is larger than the entire company’s market cap.
There’s a reason PBI just slashed its dividend in half. While the buyout news might have squeezed out some shorts, don’t think PBI is a good long-term play.
Cliffs Natural Resources
Short Interest: 40.3%
2013 Return: -46.7%
As with U.S. Steel, Cliffs Natural Resources (CLF) has been demolished in 2013 thanks to a slowdown in China gutting commodity demand — in this case, for coal as an energy source.
But bigger-picture, there are serious concerns about coal as an energy source. China has struggled mightily to control its pollution and carbon emissions that have ramped up as a result of rapid industrialization, and coal is hardly one of the favorite energy sources in the West as developed nations move away from this fossil fuel.
It’s a tough outlook for Cliffs, then, both in the short-term and the longer-term. And with natural gas still relatively cheap and abundant but cleaner-burning, it seems unlikely for the coal outlook (or the trajectory of CLF) to change.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at email@example.com or follow him on Twitter at @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.