Short selling does seem kind of weird. How can you really make money when a company’s shares fall? Well, for the most part, you are just reversing the buy process for stocks to short. That is, you borrow shares and sell them. Then hopefully you will buy them back — to cover your position — when the stock price is lower.
Keep in mind that some of the world’s top investors are pretty good short sellers. They understand that it is extremely tough for companies to keep up the growth and fight fierce competition. So why not make money off of this?
Although, there are certainly risks to short selling. Perhaps one of the biggest is the proverbial “short squeeze.” This is when a stock spikes because of the forced buying of short sellers who need to cover their positions. So yes, you really need to do your homework and not have too much of your portfolio in short positions.
Despite all this, there quite a few opportunities for shorting. If anything, the recent fall off in of the tech stocks — after a big move on the upside — is an indication that the markets could be poised for a correction.
So then, let’s take a look at four interesting stocks to short:
Stocks to Short #1: Valeant Pharmaceuticals (VRX)
Since its latest earnings report, Valeant Pharmaceuticals Intl Inc (NYSE:VRX) has been in the rally mode. But this is likely to prove short lived. The fact is that VRX is a broken company.
Until recently, the strategy was to aggressively buy drug operators, cut costs and hike prices. But given the political backlash from both Republicans and Democrats, this model is, well, ailing.
The main strategy now is to unload various assets. After all, VRX has accumulated a massive $28.5 billion debt load. Now it’s true that the asset sales have gone well so far. But it will likely get tougher. The reason is that VRX has focused on the best assets first.
In the meantime, Valeant will need to fend off its competitors — which see an opportunity to strike — and to deal with the inevitable demoralization of the workforce. This is why revenues continue to fall (they were off by 11% in the latest quarter). VRX will also have to contend with multiple drugs that will come off patents as well as the impact from legal judgments, such as over the accounting scandals.
As InvestorPlace.com’s James Brumley has noted: “Sooner or later it’s going to have to grow its revenue and income using the pieces of itself it ultimately intends to keep, and that’s something we’ve not yet seen enough of.”
Stocks to Short #2: Under Armour (UAA)
When it comes to short selling, there are often opportunities with fallen growth companies. Why? All in all, there are usually many investors that are still hoping that the problems are temporary. This means that there can be an inflated valuation. Yet as the growth continues to fade, the stock price will have to give way to gravity.
I think this is the predicament for Under Armour Inc (NYSE:UA, NYSE:UAA). Despite the evidence to the contrary, management is still boasting that the growth story is intact. And yes, there are still lots of believers on Wall Street. Note that the forward price-earnings ratio is at 42.
But consider that the UAA is taking big hits from mega rivals like Adidas AG (ADR) (OTCMKTS:ADDYY) and Nike Inc (NYSE:NKE), who have the resources to fight the brutally expensive wars for sponsorships and much broader product lines. In UAA’s latest quarter, North American sales fell by 1%, largely due to the awful performance of the footwear category.
More importantly, UAA is showing a lack of creative juice. Let’s face it, the product offerings are not showing as much differentiation. This also extends to the marketing. UAA seems to be playing from a traditional playbook of focusing on brand-name athletes. But in contrast, ADDYY has shown more moxie. Just look at the success with its sponsorship deals with hip-hop artist Kanye West.
Another nagging issue with UAA is that the company has lagged with e-commerce. For the most part, it is reliant on a distribution model focused on retailers. Yet the industry has been under assault by players like Amazon.com, Inc. (NASDAQ:AMZN) as seen with the bankruptcies of Sports Authority, Golfsmith International, Eastern Outfitters and Sport Chalet.
Stocks to Short #3: First Solar (FSLR)
Top short sellers like to see disruptive industry changes when coming up with targets. Often this involves new technologies — but it could also mean changes in politics.
So a spot-on example of the latter is First Solar, Inc. (NASDAQ:FSLR). The company is dependent on federal subsidies and tax credits.
But the Trump administration has made it clear that this kind of support will be highly scrutinized. This is evident in the move to abandon the Paris Accords But at the same time, Trump has assembled a cabinet that is far from supportive of next-generation technologies.
Yet this actually is not the full picture of the situation. Keep in mind that China — which has the toughest rivals in the solar industry — has been a big-time supporter of renewables. The government sees such forms of energy as very strategic for the growth of the country.
In other words, FSLR is really in a squeeze. By not having support of the U.S., it’s going to be extremely tough to generate sustainable returns for investors.
Stocks to Short #4: Twilio (TWLO)
There’s little doubt that Twilio Inc (NYSE:TWLO) is an impressive company. The founders were prescient in using cloud computing — back in early 2008 — to target the communications industry. They were also smart with the business model — that is, only charging for the service as usage becomes meaningful. Because of this, TWLO got quick traction with developers.
But there is something about the company that makes the shares a good short: customer concentration. This actually explains the recent weakness in the stock. During the latest earnings call, TWLO disclosed that its biggest customer, Uber, was reducing its usage of the service. In fact, from Q4 to Q1, it declined from 17% of total revenues to 12%.
But Uber is certainly not the only heavy customer. There is also Facebook Inc’s (NASDAQ:FB) WhatsApp, which accounts for hefty 9% of total revenues.
Something else: It’s troubling that these customers have top-notch engineering teams, which can develop their own solutions. But there are also many TWLO alternatives on the market, such as from Cisco Systems, Inc. (NASDAQ:CSCO), Vonage Holdings Corp.’s (NYSE:VG) Nexmo, CallFire and Bandwidth.com.
Yet the biggest risk is likely to be AMZN, which has built its own communications platform. Given its massive customer base of AWS cloud customers as well as its penchant for aggressive pricing, the company is likely to be in a position to make large gains in marketshare — and some at the expense of TWLO.
Tom Taulli runs the InvestorPlace blog IPO Playbook and is the author of various books, including All About Commodities, All About Short Selling and High-Profit IPO Strategies. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.