As many hedge funds who lost a great deal of money on their short bets recently found out, shorting stocks is a tough, dangerous undertaking. As a result, I don’t think that anyone but true experts should invest a significant portion of their capital in shorting stocks. (The latter idea explains the headline of this article). Nonetheless, sometimes shorting stocks can be profitable for traders and patient investors. When seeking stocks to short, I believe that investors should look for companies with certain qualities.
Although it may seem like common sense, some investors ignore the following: the best companies to short are those that have relatively high valuations and are almost certainly overvalued. The latter point is why I always thought that those shorting BlackBerry (NYSE:BB) stock were playing with fire. The shares’ valuation has been and remains relatively low for a tech stock.
Further, it’s important to pick names whose financial results are deteriorating or almost certainly will do so in the short or medium term.
Finally, investors should avoid shorting stocks in potentially disruptive, rapidly growing sectors, no matter how terrible a company’s financial results and outlook may seem. Those who insisted on shorting solar stocks have learned this lesson the hard way since last summer.
I believe the following meet all of the criteria that I outlined above and are good stocks to short:
Stocks to Short: XpressSpa (XSPA)
In the past, I’ve written multiple, bearish columns about XSPA stock, warning that the company, which is offering novel coronavirus tests at airports for $70 to $200, would have great difficulty competing against the many entities that are providing tests at no cost. I also theorized that smaller companies would prefer to have their employees tested at free locations, while larger firms, such as airlines, would choose to have their employees tested by enterprises with much more experience than XpressSpa.
XpressSpa’s third-quarter results, announced on Nov. 16, vindicated my view, as the company generated just $200,000 of sales in Q3, 98.4% lower than during the same period a year earlier. Based on XpressSpa’s Q3 revenue, one could theoretically expect that its sales over the 12-months that end in November 2021 would come in at $800,000.
But with the company adding more airlines as partners and expanding XpresCheck to more airports, let’s assume that its revenue for that period comes in three times as high as that projection, or $2.4 million. Given the current $280 million market capitalization of XSPA stock, that would mean the shares are trading at more than 100 times the company’s sales. That’s truly an astounding valuation.
In recent weeks, XSPA stock has soared again. I believe that the rally has been spurred by the company’s new testing facilities and its recently announced partnership with airlines, as well as rumors that Transportation Secretary Pete Buttgieg would require that all airline passengers obtain negative coronavirus tests before flying.
But President Joe Biden has reportedly nixed the latter initiative “for now.” Moreover, the few travel destinations, such as Hawaii, that require negative tests accept results from many entities, and American Airlines (NASDAQ:AAL) recently began accepting results from at-home coronavirus tests which cost only $119. In another blow to XSPA stock, more airlines could start accepting at-home tests, and such tests could become much cheaper in the near future.
Finally, within two or three months, as many millions more Americans get vaccinated, the need for testing should drop rapidly.
Bed, Bath and Beyond (BBBY)
I’m not sure how BBBY stock became a favorite of Reddit’s r/WallStreetBets crowd. But the retailer faces the same, daunting issues as most other brick-and-mortar retailers: tough competition from Amazon (NASDAQ:AMZN) and other e-commerce websites on the one hand and the highly successful giants, WalMart (NYSE:WMT) and Target (NYSE:TGT) on the other.
Unsurprisingly, Bed,Bath and Beyond’s Q3 revenue fell 5% year-over-year, and its earnings per share came in at just 8 cents, excluding certain items, 12 cents below analysts’ average estimate. Even more worrisome for the shares, during the very important Q4, which includes most of the holiday season, Bed Bath and Beyond predicted that its sales would slump at least 10% YOY.
A BBBY stock bull, Seeking Alpha columnist Bill Maurer points out that the company’s Q3 free cash flow had come in at $5.5 million in Q3, versus a loss of $62 million during the same period a year earlier. Bed, Bath & Beyond’s operating cash flow actually slumped to $106 million from $591 million in the year that ended in February 2020. And in fiscal 2019, the retailer’s operating free cash flow had come in at $918 million. The overall trend is clearly downward, and its guidance for a SSS decline of at least 10% indicates that this pattern has not been broken.
Despite all of these issues, the shares are now changing hands for a huge enterprise value/EBITDA ratio of 155 and a sizable (for what is still primarily a brick-and-mortar retailer) of 22.2.
Largely due to the pandemic, Koss has managed to improve its results markedly, as its sales jumped 18% year-over-year last quarter. Still, last quarter, which included all of the holiday season, the headphone and speaker maker managed to generate net income of only $509,000 and EPS of 7 cents. Moreover, 0ominously for KOSS stock, the retailer’s “sales through domestic retailers” actually fell YOY.
That statistic is important because it may indicate that, fueled by the pandemic, Koss is getting a temporary, metaphorical shot in the arm from foreign markets. But that catalyst will likely largely fade as more consumers get actual shots in the arm, i.e. coronavirus vaccines.
After scanning, Koss’ website, I couldn’t find any indication that that any of the company’s headphones or speakers are at all disruptive. Indeed, many competitors, including Apple (NASDAQ:AAPL) Bose, Sony (NYSE:SNE) and Panasonic (OTC:PCRFY), sell very similar products.
Nevertheless, KOSS stock is trading at a hefty trailing price sales ratio of 5.8 and a gigantic enterprise value/EBITDA ratio of nearly 650. Having fallen 78% since Jan. 29, the shares are clearly in a downward trend. And they remain nearly 1,800% above the shares’ 52-week low of 80 cents, indicating that they can drop much further. Given the company’s performance and the macro picture, I expect that scenario to materialize.
On the date of publication, Larry Ramer held long positions in BB, AMSC and GE.
Larry has conducted research and written articles on U.S. stocks for 14 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Among his highly successful contrarian picks have been solar stocks, Roku, and Snap. You can reach him on StockTwits at @larryramer. Larry began writing columns for InvestorPlace in 2015.