10 Potential Short Selling Candidates for 2014

Investors should heed some of of HDGE manager Del Vecchio's most bearish picks

10 Potential Short Selling Candidates for 2014

The life of a short selling professional can be lonely. When you celebrate a successful trade, you do it largely in private because, more often than not, everyone you know lost money.

crashing stock market 10 Potential Short Selling Candidates for 2014And when you lose? Well … don’t expect much in the way of sympathy.

Given that you are constantly going against both popular opinion and the normal upward bias of the stock market, you have to be confident in your research when you go short selling in earnest. But given that, in the words of John Maynard Keynes, the market can remain irrational longer than you can remain solvent, you also have to have disciplined risk management in place and be willing to cut your losses early.

This is a long way of saying that short sellers are a special breed.

John Del Vecchio, co-manager of the Ranger Equity Bear ETF (HDGE) — a dedicated short selling fund — and manager of the Forensic Accounting ETF (FLAG), is one of those special breeds. I reviewed Del Vecchio’s book, What’s Behind the Numbers, about a year ago, and I consider it required reading for any aspiring short seller.

I can, however, summarize the book in one short paragraph:

A sky-high valuation is not sufficient justification to short a stock, as expensive stocks often have a way of getting more expensive and gimmicky fad stocks can stay trendy longer than you think. You need a catalyst, and the signs for Del Vecchio that the jig is up are aggressive revenue recognition and inventory management. Quoting What’s Behind the Numbers, “The time to sell or short is not when you think a business model can’t survive. The time is when the numbers suggest that management is covering up poor performance.”

With the market off to a slow start in 2014 and valuations looking a little stretched, you might be itching to try your luck at short selling. Let’s take a peek at what Del Vecchio and co-manager Brad Lamensdorf are shorting to find some promising candidates.

Top 5 Short Positions as of 1/20/2014

Stock Ticker % of Portfolio
International Business Machines IBM -5.55%
CenturyLink CTL -5.22%
Fastenal FAST -3.6%
Caterpillar CAT -3.33%
Tempur Sealy International TPX -3.29%

The largest short position in the HDGE portfolio is one of the bluest of blue-chip stocks, IBM (IBM). It takes a certain amount of chutzpah to start short selling IBM given that it is one of Warren Buffett’s largest holdings, but Big Blue did have a losing year in the market in 2013 –  a year in which the S&P 500 returned 32% (including dividends).

Next on the list are telecom operator CenturyLink (CTL), industrial supplier Fastenal (FAST) and heavy-equipment maker Caterpillar (CAT), all of which have struggled over the past year. Caterpillar in particular has faced a double whammy of lower demand from emerging markets and lower commodity prices, which have discouraged new projects.

Rounding out the top five is Tempur Sealy International (TPX), which performed surprisingly well in 2013. Nearly two years ago, I wrote about the demographic trends driving Tempur’s business, suggesting that over the long term, the business faced enormous headwinds. In the immediate near term, however, it will be the family formation of Generation Y (and the resulting need for new furniture) that makes or breaks the company.

Other shorts of note?

  • Harley-Davidson (HOG)
  • Netflix (NFLX)
  • Tesla Motors (TSLA)
  • Michael Kors (KORS)
  • Kinder Morgan Energy Partners (KMP)

Last year, I wrote about “Harley-Davidson’s Flat Tire: Demographics,” and I share the managers’ bearish outlook for the company. And while I admire Netflix as a company, I have long been skeptical of the sustainability of its growth and the stratospheric valuation of NFLX stock.

Tesla Motors — which was Kyle Woodley’s pick in InvestorPlace’s 10 Best Stocks for 2014 contest (and the current leader by a wide margin) — is a risky short given its momentum, and one that I probably wouldn’t have the stomach to execute. The same goes for upstart fashion designer Michael Kors, which has taken the aspirational luxury market by storm in recent years. However, both stocks are significantly more expensive than the broader market.

Kinder Morgan Energy Partners is an interesting case. Hedgeye, a risk management and research firm, made a stir last year by calling KMP a “house of cards,” arguing that the company was engaging in aggressive accounting related to maintenance and capital expenditure spending. While I believe this is probably true, at least to an extent, I would hesitate to short a stock with heavy insider buying. As I wrote recently, Richard Kinder has put $60 million of his own money into KMP’s general partner, Kinder Morgan Inc. (KMI).

I’ll wrap this up with some general short selling advice from Del Vecchio and co-author Tom Jacobs from What’s Behind the Numbers.

First, don’t be too eager to jump into a short position. As Del Vecchio and Jacobs point out, “You make as much money shorting a stock that falls from $70 to $5 (93%) as one that falls from $100 to $5 (95%).” That’s just a way of saying that getting into a trade too early (and shorting a stock that goes up) will turn a would-be profitable short into a frustrating loss.

Second, watch out for crowded trades. Don’t start short selling a stock if the short interest is too high as a percentage of the float. This puts you at risk of being short-squeezed as your fellow sellers all scramble to buy at the same time and send the share price to the moon. One easy way to conceptualize this is “days to cover,” which is the number of shares sold short divided by the average daily trading volume. The higher this number, the more at risk you are to a short squeeze. There are no hard and fast rules here, but as a general rule I would say it’s best to keep the number below seven to 10 days for an initial position.”

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he was long KMI. Check out his new premium service, Macro Trend Investor, which includes a free copy of his e-book, The New Megatrend Investor: The Ultimate Buy-and-Hold Strategy That Will Make You Rich.


Article printed from InvestorPlace Media, http://investorplace.com/2014/01/short-selling-hdge-10-stocks/.

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