Can keeping an eye on short sellers boost your wealth?

Owning overvalued stocks might seem OK if the market keeps rising, but it could be hazardous to your wealth.

With the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) trading on a forward market multiple of about 14.5 times, the market overall isn’t exactly expensive but it’s certainly not cheap either. This makes finding potential candidates to add to your portfolio harder particularly given the number of stocks trading near their 52-week highs.

With the potential for the market to keep rising, careful selection of stocks and not overpaying has become all the more critical. As Charlie Munger — long-time business partner of Berkshire Hathaway (NYSE: BRK-B) Chairman Warren Buffett — says: “It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.”

One of the consistent themes of Buffett and Munger’s investment strategy has been to only buy stocks when they clearly understood what the stock was worth. Munger’s point is that they haven’t tried to be incredibly clever and get involved in high risk/high reward investments. Rather they have tried to remain focussed on finding investments within their “circle of confidence.”

In turn, by staying within their circle of competence, Buffett and Munger have consistently avoided overpaying for stocks, which has allowed them to consistently avoid being “stupid”.

While it is far from a certain way to determine if a stock is overvalued, keeping an eye on stocks that other investors think are overvalued can provide insights for investors. One way to do this is to view the Australian Securities & Investments Commission (ASIC) Reported Daily Short Positions.

According to the reported positions for 19 September, a number of widely held stocks had quite significant short positions against them. Shorted stocks included:

Foolish takeaway

As investor Joel Greenblatt says, determine the value of something and then pay a lot less! While short positions against a company are purely the view of a small group, from time-to-time investors may be alerted to a potential downside risk they had not considered by viewing the table of short positions. Buying stocks for less than they are worth is the key to long-term success under any conditions, however it becomes all the more important if the market as a whole is looking fully priced.

Interested in our #1 dividend-paying stock? Discover The Motley Fool’s favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of “The Motley Fool’s Top Dividend Stock for 2013-2014.”

More reading

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

Wondering where you should invest $1,000 right now?

When investing expert Scott Phillips has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for more than eight years has provided thousands of paying members with stock picks that have doubled, tripled or even more.*

Scott just revealed what he believes could be the five best ASX stocks for investors to buy right now. These stocks are trading at near dirt-cheap prices and Scott thinks they could be great buys right now.

*Returns as of August 16th 2021

More on ⏸️ Investing