What a year 2020 has been so far. Many stocks have soared back from lows seen in March to hit 52-week highs in recent weeks. However, many investors are now wondering if it is time to take off their rose-colored glasses as a new month approaches. Therefore, I will discuss three stocks to short as markets keep climbing higher.
There are different reasons why broader markets and individual stocks may decline at any given time.
For example, Shaikh Hamid of Southern New Hampshire University has studied the seasonality of market returns for small-cap stocks. He concludes that when a Republican president is in office, September sees lower-than-average returns. And in general, September sees returns significantly lower than all other 11 months.
But not all in academia agree. In fact, a different study found that in election years, the stock market rallies more often than it drops.
Thus, if we were to follow both studies, we could not predict how September or October might end. Yet we can easily conclude that we will see increased volatility.
While the upcoming election presents risks, there are other sources of uncertainty. The National Bureau of Economic Research suggests that margin credit — debt individual investors borrow to purchase stocks — could be behind the impressive rallies in hard-hit equities. And levels of this margin debt have risen in past months, corresponding with the risk-on appetite in the market.
Putting two and two together, does this mean we could see some profit-taking in the coming months?
Each portfolio is unique, so individuals need to base any decisions on their financial goals. Yet, if you hold positions in the following stocks, you may soon want to take some money off the table.
Here are three stocks to short as markets keep climbing higher:
Stocks to Short: Chipotle (CMG)
Chipotle has been a Wall Street darling so far in the year as the shares are up close to 50%. And since the 52-week low of $415 seen on March 18, CMG stock is up almost 200%. Put another way, if you were brave enough to invest $1,000 in the company in the early spring, your investment would now stand at $3,000. Currently, the stock is hovering around $1,270.
As a result of the stellar increase in share price, valuations have gone through the roof. Chipotle’s forward price-earnings and price-sales ratios are 119.1 times and 6.3 times, respectively. Some of the tech stocks that have also been charging ahead do not come close to such high valuation levels.
In late July, the food giant released second-quarter results. Revenue decreased 4.8% to $1.4 billion and comparable restaurant sales declined 9.8%. Restaurant-level operating margin came at 12.2%, a decrease from Q2 2019. Margin loss was due to higher delivery expenses associated with increased delivery sales, sales deleverage and several temporary investments due to novel coronavirus preventative measures.
Investors also noted that as consumers continued to work from home, digital sales grew 216.3% and accounted for 60.7% of sales for the quarter.
Overall, Chipotle is a great restaurant business. However, pandemic challenges are still with us. And the most recent financial results, coupled with the valuation levels, make it one of my stocks to short.
If you are currently a shareholder, it may be time to de-risk.
Credit Acceptance Corporation (CACC)
Michigan-based Credit Acceptance Corporation offers financing programs to domestic automobile dealers to sell vehicles to consumers, regardless of their credit history. Its history goes back to 1972. It is a robust and well-run company with sound management.
And its long-term price is a testament to the company’s strength. In August 2010, CACC stock was around $50. Now, it is around $460. That is a growth of 820% in a decade, or compound annual growth rate (CAGR) of 24.9%. Put another way, $1,000 invested in CACC stock a decade ago would now be worth over $9,000.
On July 30, the group released its Q2 earnings statement. Consolidated net income was $96.4 million. Unfortunately, that figure was sharply down from consolidated net income of $164.4 million in 2019.
“Starting in mid-March, we experienced a substantial reduction in demand for our product and a significant decline in cash flows from our loan portfolio that lasted through mid-April, after which collections and new loan volumes improved significantly. As the virus is not yet contained, the ultimate impact of the pandemic on our business is not yet known. The impact will depend on future developments.”
As the second wave of the pandemic continues to make headlines, Credit Acceptance is likely to see ebbs and flows in operation. The company’s forward P/E and P/S ratios stand at 28.3 times and 5.6 times, respectively. Those are rich ratios for a company that is likely to be affected by a further contraction in the economy.
Are you an investor who also pays attention to short-term technical charts? Then you may be interested to know that CACC’s charts are also reason for caution. So far in the year, the shares are up over 4%. However, that metric tells only half the story. Since hitting a 52-week low of $199 on March 23, CACC stock is up an eye-popping 130%.
The stock is likely to come under pressure and fall toward the $400 level. Therefore Credit Acceptance is a stock to short in the short term.
Stocks to Short: McCormick & Company (MKC)
McCormick & Company is another high-quality name whose valuation has gone too high in the past few months and may thus be due for a pullback soon. The company’s forward P/E and P/S ratios stand at 36.5 times and 5.02 times, respectively.
In late June, the global flavor leader announced robust Q2 earnings. Sales rose 8% in the second quarter. And adjusted earnings per share rose to $1.47 from $1.16. CEO Lawrence Kurzius said:
“Our exceptional consumer segment growth was driven by the substantial increase in demand as consumers were cooking more at home. In our flavor solutions segment, our results were significantly impacted by sharp declines in demand from restaurant and other foodservice customers as away from home dining was significantly curtailed.”
Year-to-date, MKC stock is up close to 20%. However, since the lows hit in March, shares are up close to 90%. The markets have been buoyed by hopes of a vaccine as well as a V-shaped market recovery.
However, with an increasing number of Covid-19 cases, there could once again be at least partial lockdowns, in which restaurants could not operate at full capacity. That would mean a setback for revenues for McCormick.
In the coming weeks, I am expecting the stock to come under pressure and decline toward the $180 level. Therefore, MKC is a stock to sell.
Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education, including a Ph.D. degree, in the field, she has also completed all three levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. She also publishes educational articles on long-term investing. As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.