I’ve never been much of short-seller. The problem with short-selling is that you are playing against the house. In the long term, the stock market has a positive expectation. If you hold long enough, you are going to see a positive return on most stocks. That’s the opposite of a casino, where the long-term expectation is negative, since all games are stacked in the house’s favor.
However, as with all large samples, there are inefficiencies. In the stock market, it comes in the form of lousy companies. To me, there is a brief period where you should short a stock. It’s when the company crosses a threshold where it is clear that it isn’t going to survive. The trick is noticing that threshold at just the right time.
If you short too late, you still will make a profit but not as much as others who took a greater risk. If you short too early, you could get smacked around because there will always be true believers and momentum traders who mess up your plan.
With all this in mind, let’s take a look at three of the best stocks to short.
Stocks to Short — Sears Holdings (SHLD)
Sears Holdings (SHLD) seems like an obvious candidate for stocks to short … but it has also made many a short-seller gnash their teeth. One look at a two-year chart will show the roller-coaster ride for a company that really has no business still being in business. I got burned trying to short it in the mid-30’s, then saw it drop 10% only to rocket above $42 as I got stopped out.
Sears just borrowed $400 million from affiliates of the CEO’s hedge fund, secured by 25 of the company’s stores. The deal matures in just three months and the loan earns 2.5%. That sounds like the death knell to me. Considering cash flow has fallen from $1 billion to $2 billion this year, and the company is already loaded with debt, I think the end is near.
The stock is still at $27, but I think that’s because people somehow see real estate value in here. That may be true, but if the company goes bankrupt, that real estate will be seized by creditors. Now may be the time to short with a stop at $32.
LinkedIn (LNKD)
LinkedIn (LNKD) seems to have become the darling of momentum investors. Despite being more than 15% off its all-time high, LNKD stock still trades at around $210.
Now, analysts are projecting long-term annualized EPS growth of 38%. I think that’s crazy. But even assuming they’re right, and putting a 38x estimate on FY15 expected earnings of $2.74, the stock should be trading at $104. Even backing out the $20 per share in cash it has, LNKD stock is still crazy overvalued, which is why it makes my list of stocks to short.
LNKD is trading at 76x next year’s earnings and 110x this year’s earnings. This business doesn’t generate great cash flow, as you might expect from an e-commerce play. And the truth is, its business is just a professional version of Facebook that people pay too much for. Short LNKD stock, but with a tight stop because of momentum.
CenturyLink Inc. (CTL)
I think CenturyLink Inc. (CTL) may make for an interesting short. Telecom firms have an interesting structure. Most of them carry a ton of debt, but their free cash flow is spectacular, so debt can be serviced and a hefty dividend paid, much as AT&T (T) does. However, CTL stock has more than $20 billion in debt, costing it about 6% per year. It just sold $500 million worth of 6.875% notes due in 2054.
The rate suggests a high degree of risk, but the maturity date suggests 40 years of operations to come. CTL is FCF positive, and nicely so, but net income has been struggling a bit. It pays a 5.5% dividend, which attracts dividend investors.
I think, however, that Century link is overvalued based on its modest-to-weak financials. I think it has benefited from yield chasers and when interest rates start to rise, it will fall. CTL ranks on our list of stocks to short — but short it with a 7-10% stop loss, and double-down when interest rates rise.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at pdlcapital66@gmail.com and follow his tweets at @ichabodscranium.
