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Should you buy these heavily shorted shares?

In the last 12 months short sellers have had a lot of success targeting the likes of Blue Sky Alternative Investments Ltd (ASX: BLA), Myer Holdings Ltd (ASX: MYR), and Retail Food Group Limited (ASX: RFG).

But they don’t always get it right. An example of this would be Nanosonics Ltd (ASX: NAN). It has inexplicably been targeted by short sellers this year and has around 11% of its shares held short at present. However, its shares have risen 38% in the last 10 weeks despite this.

With that in mind, should you defy short sellers and buy these heavily shorted shares?

Domino’s Pizza Enterprises Ltd (ASX: DMP)

On Monday this pizza chain operator was the third-most shorted share on the local market with 15.3% of its shares held short. Short interest shot higher over the last 12 months over concerns that Domino’s growth was slowing and that it would fail to meet its guidance. Over the last couple of months the broker community has been largely divided on FY 2018. Some believe things have improved enough for the company to meet its guidance, whereas others believe its international businesses are acting as a drag and will result in a miss. I think Domino’s is a great long-term investment due to its plan to double its store network and expand its margins over the next seven years. However, with earnings season just around the corner, it may be prudent to wait for its results release before acting.

Galaxy Resources Limited (ASX: GXY)

At the start of the week this lithium miner had 14.4% of its shares held short. Short interest rose sharply after a bearish broker note out of Morgan Stanley earlier this year claimed that lithium prices would halve in value over the next few years as new supply hits the market. While I think Morgan Stanley makes a fair point about what could happen, I’m not convinced that it will be the case. All the major players in the industry intend to bring on new supply when necessary and not flood the market. Furthermore, it takes considerable time to commission a lithium operation, which gives a lot of visibility to near-term supply additions. And given that battery makers have been scrambling to lock in lithium supply with multi-year offtake agreements, it appears that the buyers of the metal aren’t expecting an oversupply any time soon. In light of this, I expect Galaxy and fellow heavily shorted lithium miner Orocobre Limited (ASX: ORE) could continue to profit from high prices for some time to come. This could make both lithium miners a good, but high risk, option in the resources sector.

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Motley Fool contributor James Mickleboro owns shares of Galaxy Resources Limited. The Motley Fool Australia owns shares of and has recommended Nanosonics Limited. The Motley Fool Australia has recommended Domino's Pizza Enterprises Limited. 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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