Should you sell these heavily shorted ASX stocks?

Occasionally it’s worth taking a look at what the most heavily shorted stocks on the ASX are as if hedge funds are betting on them falling they must have reasons for taking these positions.

Hedge funds borrow stock from the prime brokerage arms of investment banks like UBS in order to sell it on market and hopefully buy it back cheaper at a later date to profit from the difference. The prime broker charges fees (usually less than 100 basis points of the value of the stock lent) in return for lending the stock.

Short selling can be profitable as stocks tend to fall faster than they rise, although it is a high-stakes game that sometimes requires steel nerves as positions can increasingly drift out of the money. However, normally actively-trading hedge funds only need to be right 50% of the time due to the phenomenon of markets and stocks generally falling faster than they rise.

Let’s take a look at six heavily shorted shares on the ASX and consider why they may be short sold. All short sell percentages are correct as of 30 June 2016.

Asaleo Care Ltd (ASX: AHY) has 6.4% of its shares shorted. It sells toiletries like Sorbent and Libra in Australia and Asia with short sellers probably betting it’s overvalued at $2.07 a share.

Bellamy’s Australia Ltd (ASX: BAL) has 10% of its outstanding stock shorted. The baby formula business trades on a high multiple of estimated earnings with plenty of growth baked into the share price of $10.15. Short sellers may be betting that regulatory changes in China force a sales slowdown and whether they’re correct remains to be seen.

Corporate Travel Management Ltd (ASX: CTD) has 7.9% of its stock shorted. UBS is lending out the stock and today the AFR reported that an analyst at Credit Suisse is questioning the stock’s valuation via-a-vis the level of organic growth at the business. The company is forecasting earnings growth in the region of 38% in financial year 2016 and short selling this share looks a risky strategy.

Flight Centre Travel Group Ltd (ASX: FLT) has 11.6% of its shares shorted. The business is a favourite of short sellers and has issued several profit downgrades in recent years. Current forecasts are for profits to fall 2%-5% in FY16 and in my opinion if the Australian dollar remains weak this is a negative for the group’s substantial Australian operations over the year ahead.

JB Hi-Fi Limited (ASX: JBH) has 7.6% of its stock shorted. The consumer goods business trades on a high earnings multiple for a retailer unlikely to shoot the lights out anytime soon. At $23.66 the shares are near a record high with great expectations for a strong full year result in August.

Metcash Limited (ASX: MTS) has 14.9% of its stock shorted. The IGA supermarkets operator and wholesale supplier has traders betting against it due to Australia’s increasingly competitive groceries industry. The stock has also climbed 17% over the last few months, which has probably encouraged the sceptics to bet further against it. Shares look to have downside risk given the competitive outlook.

3 Rotten Shares to Sell, and 1 to Buy Today

After a double-digit rally for the ASX since 2016 lows, investors should be on high alert. You'll find a full rundown below of 3 shares we think you should avoid today plus one top pick worth buying, even if the market turns south and the RBA keeps rates at an "emergency low." Simply click here to uncover these stocks.

Motley Fool contributor Tom Richardson owns shares of Bellamy's Australia and Corporate Travel Management Limited. The Motley Fool Australia owns shares of Bellamy's Australia.

You can find Tom on Twitter @tommyr345

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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