Should investors avoid these 7 stocks?

Some investors certainly think so!

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Short sellers often get a bad name. The idea that someone is "betting" or "hoping" that a company's share price will do badly is often viewed as "unsporting" – for want of a better word. In reality however, shorting goes to the heart of investing. That is, if you believe at the heart of investing is valuation.

What is short selling you ask?

Short selling is a transaction which enables an investor to profit if the share price of a company declines. While most of us look to buy shares with the hope of making a profit by the share price going up, the short seller essentially operates in reverse.

While shorting is often viewed as in the realm of speculation and trading, often however, a short seller is every bit the value investor. A short seller needs to be incredibly sure that he or she has accurately identified over-valuation in a stock.

Here are seven of the most shorted stocks on the ASX at the moment:

  • Atlas Iron Limited (ASX: AGO)
  • Myer Holdings Ltd (ASX: MYR)
  • Silver Lake Resources Limited. (ASX: SLR)
  • Australand Property Group (ASX: ALZ)
  • BC Iron Limited (ASX: BCI)
  • Metcash Limited (ASX: MTS)
  • Ansell Limited (ASX: ANN)

Exactly how useful and how much weight investors should place on the short interest in a stock is debatable. From time-to-time it could raise a red flag about a company specific issue which an investor has failed to fully consider or provide due weight to in their analysis. Under these conditions understanding short interest in a stock can be very useful.

However long-term investors will often find that much of the short interest is more focussed on momentum such as the near-term direction of the gold price, or simply that a short is being used as a hedge rather than serious analysis as to the long-term profitability of a firm. In these cases, they can generally disregard short interest.

Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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