Should you stay away from these top 10 shorted stocks?

Heavily short-sold stocks can give investors an idea of sectors or individual companies to avoid.

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Shorting, also known as “to go short” or “short-selling” is one way in which investors can profit from a decreasing share price.  Short selling is essentially the opposite to the long-term “buy low, sell high” strategy.

The process is as follows:

  • The short seller identifies a stock they believe will drop in price in the coming months.
  • An owner of the shares is approached and offered a cash fee (usually 0.3%-0.5% of the price) to allow their shares to be borrowed by the short seller.
  • The shares are then sold and the proceeds received by the short seller.
  • At some time in the future, the shares are then re-purchased by the short seller and transferred back to the original owner.

Short sellers make money when the value of the re-purchased shares is less than what the original shares were sold for, plus fees. Because of the risks and small market involved, short selling is a highly regulated and specialised investing market, with participants usually well informed of potential corporate news and company health. As a result, investors may use shorting statistics as a means of determining future market trends.

ASIC publishes short position statistics at a three day lag to the market (ASIC) from 2010 onwards. The following table shows the top 10 shorted ASX-listed stocks and their % of free-float shares shorted on 25/5/13 and 20/6/13, and the change over that time.

Code

25/05/2013

18/06/2013

Change (%)
FXJ

14.92

17.92

+3.00

JBH

17.01

16.65

-0.37

MYR

13.24

14.28

+1.04

PDN

13.07

12.37

-0.69

FLT

11.62

12.02

+0.40

ILU

13.09

11.46

-1.63

MND

10.55

10.57

+0.02

DJS

10.42

10.33

-0.10

WHC

10.25

10.12

-0.13

NWH

9.93

10.01

+0.08

Based on the state of the Australian economy at present, it’s no surprise that the majority of highly shorted companies are either retailers or from the mining/materials sector. These are seen as the areas most under threat by a weakening Australian and Chinese economy. Fairfax is shorted heavily due to the uncertainty surrounding the drastic change in business model being undertaken by the company.

A glance at the share price of the top 10 companies over the past month shows an even spread of performances, with David Jones (ASX: DJS), JB HiFi (ASX: JBH), Flight Centre (ASX: FLT), Whitehaven Coal (ASX: WHC), and Monadelphous (ASX: MND) having outperformed the ASX 200 (ASX: XJO), while Fairfax (ASX: FXJ), Iluka (ASX: ILU), Paladin (ASX: PDN), NRW Holdings (ASX: NWH), and Myer (ASX: MYR) have underperformed.

Foolish takeaway

The short position information available from ASIC can give investors an idea of the negative sentiment surrounding a stock, but a high percentage of sold short shares does not guarantee poor performance. Investors may be better suited understanding the trends in the statistics, such as a high amount of shorting in particular sectors, in order to make investment decisions.

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Motley Fool contributor Andrew Mudie does not own shares of any companies mentioned in this article.

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