Since last June, I’ve sold nine portfolio holdings in my premium income newsletter, High-Yield Investing. All nine were for positive gains, between 2.1% and 74.1%. But I didn’t sell any of these stocks because I expected them to decline. Rather, most had lived up to their short-term potential and the time had come to cash out gains and look elsewhere for candidates with stronger upside.
But there are investors who do actively bet against certain stocks by selling them short. In the simplest terms, this involves borrowing the shares and immediately selling them. A few weeks or months later, the shares are repurchased (ideally at a lower price) and returned to the original owner, with the trader keeping the difference.
It’s “buy low and sell high” in reverse order.
It’s a risky strategy. If you buy a stock at $10, the most you can lose is $10. And that’s only if it winds up completely worthless. But if you sell short at $10, the stock can rise to $20, or $30, or more. The more it rises, the more you lose. So in theory, the potential risk is unlimited (although in practice traders take steps to cap their losses).
That’s why short sellers typically do their homework and identify specific, concrete reasons why a stock is poised to fall. They can also disseminate false or misleading information to spook investors, so be careful. But that doesn’t mean they are always right. Many get it wrong and wind up losing their shirts on these trades.
My favorite example is Sirius XM Holdings Inc. (SIRI). The satellite radio provider has been one of the most hated stocks on the market, judging by the number of people who have shorted it over the past two years. Some of the bears point to rising customer acquisition costs or growing competition from free online music streamers like Pandora Media Inc (P).
But I challenged these assumptions and recommended the stock to readers of another one of my newsletters in May 2014 at a price of $3.15. Since then the subscriber count has ballooned to 30 million and the stock has confounded the skeptics and climbed to $4.60.
That slow but steady upward march has gradually shaken out many of the short sellers over time. But sometimes, this process unfolds very abruptly.
It usually starts with some positive piece of news (like an upbeat earnings forecast). That triggers a rally in the stock, which causes many short sellers to panic and exit the trade (buying to replace the borrowed shares). That buying exerts more upward pressure on the stock price, which in turn makes more short sellers scramble to cover, which then pushes the stock even higher.
It’s called a “short squeeze” in industry parlance.
It happened recently with Dow Chemical Co (DOW). A few weeks ago, there were 88.2 million shares sold short. Most were betting that the company’s proposed $60 billion merger with DuPont would be blocked by European regulators, leading to a hasty decline in the stock.
But there have since been indications that the deal will pass muster and gain regulatory approval (the good news I referred to above). Suddenly, there was a stampede for the exits among short sellers (which means heavy buying). Today, there are just 10.1 million shares being shorted — a decrease of nearly 90%.
And over the past 60 days, DOW shares have surged straight uphill.
Reliable dividend payers aren’t frequent targets of short sellers, partially because they are less erratic, but also because any dividends received while the shares are short must be repaid to the lender (so there are higher frictional trading costs).
But in the chart below, I’ve found a handful of high-yielders that might make for good short-squeeze candidates.
If you’re looking for income — but also a potential short-term bounce from these bearish investors being wrong, then this is a good place to start.
|Company||Industry||Yield (%)||Short Interest ($M)|
|Compass Minerals (CMP)||Minerals||3.5||6.5|
|Helmerich & Payne (HP)||Oil & Gas||3.5||17.9|
|Shaw Communications (SJR)||Telecom||4.2||4.5|
|Lamar Advertising (LAMR)||Advertising||4.1||6.2|
|Regal Entertainment (RGC)||Theaters||4.0||17.8|
|Iron Mountain (IRM)||REIT||5.9||13.7|
My initial stock screen identified dozens of heavily-shorted stocks, some of which have wounds that are laid bare for all to see.
For example, navigation systems maker Garmin Ltd. (GRMN) is fighting an uphill battle because GPS technology is embedded free on most cell phones these days. SeaWorld Entertainment (Nasdaq: SEAS) is under siege from animal rights activists. And Medallion Financial Corp (MFIN), which lends money to cab drivers, is facing an existential threat from Uber.
The companies in the table above don’t appear to be in any such danger. Sure, they have everyday concerns, like any other company. But each possesses a proven business model with entrenched competitive advantages.
My High-Yield Investing subscribers and I already know about Lamar Advertising, which generates buckets of predictable income from 325,000 highway exit signs and billboard rentals. With state and federal laws blocking out the competition, the company has lofty free cash flow margins and pays the 9th-highest yield in the S&P 500.
Despite all that, there are 6.2 million shares of LAMR sold short. Based on average daily trading volume of 579,000 shares, it would take almost 11 days to fully close out all those short positions. The stock is already at a 52-week high and could climb even further if something happens to make these short sellers walk away.
Aside from Lamar, I think Regal Entertainment also deserves a close look. The multiplex movie theater owner just signed an expanded deal with IMAX Corporation (USA) (IMAX) and has a promising slate of new releases on the horizon to fill seats (at ever higher ticket prices). The stock’s solid 4% yield is double the market average.
As always, the names on this screen shouldn’t necessarily be considered automatic portfolio candidates, as most of them haven’t been fully researched. This is just a starting point from which to conduct a further evaluation. I will tell you though, that Lamar is one of many holdings we own in High-Yield Investing. (If you’re looking for more high-quality income picks, I suggest you learn more about our newsletter here.)
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