Finding Stocks to Short: A Strategy for Intrepid Investors
As the market continues its upward trajectory, finding lucrative stocks to buy has become increasingly challenging. However, intrepid investors may want to consider a different approach – looking for stocks to short, or bet against. The S&P 500 has experienced a remarkable 22% surge since hitting a multimonth low in October. This rally, which has not only benefitted Big Tech but other sectors as well, has made it harder to find stocks with room for further growth. Yet, if the earnings outlook darkens, many shares have the potential to experience significant declines.
Short selling presents an opportunity for investors to profit from these potential drops. By borrowing someone else's shares and immediately selling them, investors can generate profit if the stock price falls. However, short selling is not for the faint of heart. Historically, stocks tend to rise over time, making it crucial for short sellers to accurately predict a stock's decline within a specific time frame, usually six months. Additionally, if a positive catalyst causes a shorted stock to rapidly rise, short sellers may be forced to buy the stock quickly to cover their bets, resulting in greater risks and potential losses.
This week, analysts at Wolfe Research have published a screen of stocks that appear to be good short candidates. The screen focuses on stocks with valuations that may be too high relative to their earnings potential, as well as poor earnings quality or low earnings predictability. Notable stocks highlighted in the screen include Plug Power, ADT, Tesla, Walgreens Boots Alliance, Hasbro, and ViaSat. Current market positioning suggests that these six stocks could experience increased short selling activity. It is worth noting that many of these stocks also carry substantial debt burdens, with Walgreens being a prime example. The company's liabilities, including debt and lease obligations, exceed $30 billion, more than six times its expected 2024 Ebitda. In comparison, many S&P 500 companies have debt-to-Ebitda ratios deemed less risky, typically around one or two times. Walgreens' declining profits in recent years further compound the risk associated with its debt levels.
However, despite Walgreens' 40% decline over the past year, its valuation does not necessarily make it an attractive investment. While the company's enterprise value is approximately 6 times its expected 2024 Ebitda, compared to the S&P 500's 13 times, this multiple is driven by a decline in profits over the past several years. Investors are eagerly anticipating a turnaround in the company's financial performance. Additionally, a significant portion of Walgreens' Ebitda goes towards expenditures, with less than $1 billion of free cash flow from $4.9 billion of Ebitda in 2023. These factors, coupled with the low short interest of approximately 5.1% of shares outstanding, contribute to the potential for short sellers to return to the stock.
Another stock that may initially seem cheap but carries its own risks is Hasbro. Trading at 15 times expected earnings per share for 2024, compared to 20 times for the S&P 500, Hasbro may appear reasonably priced. However, closer examination reveals decline in the company's per-share earnings in recent years. Even this year's projected earnings would be below 2019 levels. Further weakness in earnings could lead to additional declines in the stock price. Furthermore, Hasbro's net debt is approximately three times its expected Ebitda for 2024, a higher multiple than the S&P 500. Unless the company can grow its profits or reduce its debt, short sellers may find the stock appealing. Currently, only about 5.6% of shares are shorted.
While stock screens provide a starting point, investors must conduct thorough research into individual companies to make informed decisions. However, for those daring enough to take on the risks, short selling could offer significant rewards.
Analyst comment
This news can be evaluated as negative. The market has been difficult for investors to find stocks to buy as it has rallied higher. However, analysts at Wolfe Research have identified stocks with high valuations, poor earnings quality, and high debt loads that could be good short candidates. Stocks mentioned include Plug Power, ADT, Tesla, Walgreens Boots Alliance, Hasbro, and ViaSat. The short sellers may profit from potential stock declines, but it is a risky trade. Walgreens and Hasbro are specifically highlighted as stocks with declining profits and high debt, making them potential targets for short selling.
