3 shares to outperform after seeing the biggest drop in short-sellers this month

Are we jumping from the frying pan into the fire? While investors will be happy to see the back of May given its dubious reputation as a bad month for shares, history has shown that June is usually a worse time for our market.

This isn’t troubling investors on the last day of May though with the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) chalking up a 0.4% gain in afternoon trade following a strong lead from Wall Street last night.

But there are a number of stocks that could defy the potential June sell-off as short sellers are rapidly closing off their bearish bets on these companies. This is usually a sign that the targeted shares are at a turning point and could run higher in the near-term – as long as the short sellers don’t return.

Short sellers borrow stock to sell on market with the aim of buying it back cheaper at a later point to profit from the difference. Short sellers tend to be sophisticated investors, so it can be pretty insightful to look at what this group is up to.

These bearish traders have been beating a hasty retreat from consumer financing firm Afterpay Touch Group Ltd (ASX: APT), which has seen the greatest drop in short selling interest since the start of May, according to the latest data from ASIC that is always a week behind.

The percentage of its shares that are on loan to short sellers tumbled to 4.7% from 9.6% this month. I think the stock will keep outperforming in June and possibly beyond.

Short sellers had targeted the company earlier this year on reports that under-age consumers were using the service to purchase alcohol. There were worries that ASIC will also move to regulate the business as it does with other consumer loan companies and payday lenders.

But management has managed to convince the market that it has tightened its procedures and that regulators had no plans to change the rules.

Further, Afterpay’s launch into the world’s largest consumer market, the United States, is exciting growth seeking investors.

The stock taking second place for beating back short-sellers is hospital operator Healthscope Ltd (ASX: HSO), which received and rejected two takeover bids.

The percentage of shorts fell a material 3.4 percentage points to 3.8% this month as short-sellers got spooked by the $2.36 per share offer for Healthscope from BGH Capital-AustralianSuper consortium and a $2.50 a share marriage proposal from Brookfield Asset Management.

While Healthscope has thumbed its nose at both suitors, short sellers are probably loathed to return as management is exploring a sale and leaseback arrangement for its 29 freehold properties, which are likely to fetch significantly more than their $1.3 billion value that the company has ascribed to these assets on its balance sheet.

Not coincidentally, fellow takeover candidate BWX Ltd (ASX: BWX) is in third spot as short interest in its shares dropped 2.9 percentage points to 7.2%.

The embattled skin care products maker has become subject of a management buyout with its chief executive John Humble and finance director Aaron Finlay teaming up with private equity group Bain Capital to lob a $6.60 takeover offer for BWX.

It’s anyone’s guess where this will end up with BWX hiring investment bank Macquarie Group Ltd (ASX: MQG) to help with its defence.

Short-sellers will probably keep away from this stock until there’s greater certainty on whether the deal will get consummated.

But these stocks aren’t the only ones that could potentially outperform in 2018. The experts at the Motley Fool are bullish on a niche group of stocks, which they believe will make a big impact on our market.

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Motley Fool contributor Brendon Lau owns shares of AFTERPAY T FPO and Macquarie Group Limited. The Motley Fool Australia owns shares of and has recommended BWX Limited. The Motley Fool Australia owns shares of AFTERPAY T FPO. 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 Scott Phillips.

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