When it comes to investing in individual equities, investors have two ways to play them: buying long or selling short.
Buying long is simply buying a stock with the hope that shares will go higher in the future. Short selling is essentially buying a stock with the hope that shares will go down in price. While to some investors that may sound confusing, short selling serves as a way for investors to profit from stock — just not the usual way.
The way short selling works is that an investor puts in a trade that states they are actually selling shares of a company (hence “short selling”) at a certain price. That investor closes the trade by buying shares (“covering”), hopefully at a lower price, thus making a profit. If you short sell a stock at $10 and it drops to $5, you can cover for a $5 gain.
But, remember, when short selling, investors’ gains are capped at 100%, because a stock can only go down by 100% from where you purchased or sold it originally.
The risk in short selling is that a stock can go higher by an infinite amount. So if you open a short position at $10 and the stock goes up to $15, and you close it out, you just lost $5 per share, and now you owe your broker instead of making a profit. And because there’s theoretically no cap on how high a stock can go, there’s theoretically no cap on how much you could owe on a bad trade.
So before you do open a short position, make sure you fully understand the risks, possibly set a stop loss, and of course have the money to cover any possible losses.
With that said, let’s take a look at a few stocks that might be worth shorting.
Stocks to Short: Weight Watchers (WTW)
Weight Watchers (WTW) hit the news reels and the stock has jumped more than 300% over the last three months after it was announced Oprah Winfrey has taken a 10% stake in the company and would be joining the company’s board of directors.
The jump is a big win for shareholders who previously owned WTW stock, but now investors need to ask if Oprah’s involvement is really going to make a long-term difference to the company, and whether it’s really worth a 300% move.
I personally don’t think it matters over the long term.
While there are a number of studies on different diet programs, a Duke University study found that Weight Watchers program cost users an average $377 per year to lose just 5 pounds. Yikes.
Perhaps as a result, the company faces declining revenue and a shrinking active user base. This problem has plagued Weight Watchers in the past as its customer base continues the yo-yo dieter trend (jumping from one new hot diet trend to the next).
Now that Oprah is all-in with Weight Watchers, new and previous customers may give WTW another chance, but if actual weight loss results aren’t produced in a timely fashion for both WTW’s popular new partner and its clients, the stock will fall quickly as revenue and users again begin to decline.
When that happens, Weight Watchers shorts will have a lot to gain.
Stocks to Short: Fitbit (FIT)
Speaking of weight loss, Fitbit (FIT) shares have fallen hard since the start of November, down more than 20%.
The maker of the wearable health and fitness tracker went public in June of this year, and after shares climbed higher during the following weeks, they’re now trading slightly lower than their IPO price. Despite many Wall Street analysts now placing “buy” ratings on the stock, FIT should still be considered as a short selling candidate.
Fitbit has the same problem as Weight Watchers: Dieters are a flaky bunch, and healthy lifestyles can fade away over time. Fitbit is also a one-time purchase, with nothing in the way of recurring revenues. This type of business model has time and time again been proven to be very difficult in any industry, let alone the health and fitness arena were we are constantly being inundated with the next new way to lose weight and get healthy.
That brings us to the biggest problem: competition. With the likes of Apple (AAPL), Samsung (SSNLF), Alphabet (GOOG, GOOGL) and countless other much smaller players fighting for market share, Fitbit needs to spend heavily on new innovations and marketing, and its current $500 million in the bank won’t cover those needs over the long term.
However, investors should wait until the holiday quarter earnings are reported before short selling the stock, because this quarter is historically a strong time for the company.
Stocks to Short: Lumber Liquidators (LL)
Another stock that has been down over the last few months and has room to keep falling is Lumber Liquidators (LL), dropping more than 30% over the last six months and nearly 80% year-to-date.
The issues with Lumber Liquidators go beyond the illegal wood being cut down in Russia and much larger than the 60 Minutes report about possibly unsafe levels of formaldehyde in its Chinese sourced laminate flooring.
Lumber Liquidators is in the flooring business, which has essentially become a commoditized industry. In the past, Lumber Liquidators had cheaper prices and high profit margins, making it a good investment because it was cutting corners.
If the 60 Minutes report is true, the only way one Lumber Liquidators can maintain its competitive advantage of cheaper prices moving forward is by reducing it margins, which makes it a much less attractive investment option.
If Lumber Liquidators plays on an even field with other flooring retailers, prices will likely move higher, making it more difficult for the company to attract customers. The company’s high margins, which LL bulls have loved over the last few years, will fall. When that happens, the bulk of the appeal of owning LL shares fades, making short selling LL stock today a profitable move.
As of this writing, Matt Thalman had no positions in any company mentioned. Follow him on Twitter at @mthalman5513.