Category Archives: Short

Kabel Deutschland & Vodafone reloaded

One of my two remaining short position gets “smoked” today. Kabel Deutschland is up ~7% to a new ATH:

The reason is once again the (now somehow confirmed) rumour that Vodafone wants again to take over KAbel Deutschland:

It started (again with the “rumour” as last time:

(Reuters) – Vodafone Group Plc has made an informal takeover bid within the past week for Germany’s biggest cable company, Kabel Deutschland Holding AG, Bloomberg reported, citing people with knowledge of the matter.

In the meantime, to my surprise, Vodafone confirmed the talks:

LONDON—Vodafone Group PLC said it has approached Germany’s biggest cable operator Kabel Deutschland Holding AG about a possible takeover, a move that would mark the U.K. mobile-phone company’s largest acquisition in Europe in more than a decade and add more customers to its triple-play offering of TV, mobile and broadband.

“There is no certainty that any offer will ultimately be made, nor as to the terms on which any such offer might be made,” Vodafone said in a brief statement Wednesday.

Kabel Deutschland confirmed it has received a preliminary approach from Vodafone, but also said there is no certainty an offer will be made.

So this is clearly against my expectations when I made the short. I have to admit that I don’t understand Vodafone. Why would they start such talks again with the danger of a leak again when the exact same thing happened a few months ago.

My only explanation is that they are either extremely desperate or extremely stupid. Or both.

Vodafone shareholders didn’t seem to be too enthusiastic either. So lets wait and see what happens. One first lesson is clear: Never underestimate the stupidity of others. Vodafone has done already one horrible overpriced German acquisition (Mannesmann) in the past. However, most likely most of those people who did this back then were already fired and now they make the same mistake again.

Clearly I also made a mistake here. It is definitely much more risky to short stocks with no majority shareholder in an industry which is famous for overpaying for M&A transactions.

EDIT: Real time comment for a quite “famous” Vodafone investor:

Vittorio Colao the urbane but seemingly incompetent CEO of Vodafone is the new Sir Fred Goodwin.

Kabel Deutschland (DE000KD88880) – Short again !!

Kabel Deutschland is a stock which I have written about quite often. I was short the stock but closed out with a quite significant loss (-53% to be exact).

I am still following the stock out of interest because I think it is a prime example of a modern day high quality “stock promotion”.

Clearly, the performance of the stock since its IPO is outstanding. Without many setbacks, the stock has tripled since its MArch 2010 IPO, making it one of the most succesful German stocks in that time period:

Also the advantages of Kabel Deutschlands business model are clear:

- the business seems to be a “natural moat” business. Effectively, Kabel Deutschland makes contracts with the administers of multi family homes, so all those people become automatically clients of Kabel Deutschland and have to pay a base fee via their monthly rent bill. With this guaranteed inflow, Kabel Deutschland is then able to sell aggressively phone services, internet etc. to those clients

As a result, Kabel Deutschland is supposed to be a free cash flow machine with still significant growth potential, the rare exception in the European TelCo market. So it doesn’t matter that Kabel Deutschland has negative equity and the debt is mostly covered by goodwill and intangible assets.

Markets are clearly paying a premium for that. With a trailing EV/EBITDA of 11.4, Kabel Deutschland is ~30% more expensive than even the comparable cable operators in Europe and the US.

Recent developements

Telecolumbus acquisition

Kable Deutschland was on track to take over Telecolumbus, another regional cable operator. Taking over other regional cable operators is of course a no brainer for any aspiring cable company. Economics of scale is what counts in cable. However 3 days ago, the german antitrust office finally rejected the request from Kabel Deutschland due to anti trust concerns.

So this significantly reduces growth opportunities for Kabel Deutschland. Yes, they might be able to sell more internet etc. to existing clients but I am not sure if this really warrants the extra price paid for Kabel Deutschland

9m results

The official release came out with an encouraging dividend increase from 1.50 EUR to 2.50 EUR per share. Also all their self defined funky KPIs look fantastic.

However if you really look into the cash flow statement, one can see that 9 months free cashflow is only ~50 mn EUR, to significantly increased investments. The company even announced an “accelerated network investment” plan:

In order to enable accelerated growth, the Company intends to pull forward network investments of €300 million to be spent over the course of the next two fiscal years in addition to the Company’s existing investment plans.

Interestingly, the “operating cashflow” does not include interest charges. In my opinion, interest charges are operating, as they have to be paid regularly and there is no discretion like dividends. So in my view Kabel Deutschland currently runs free cashflow negative and dividends are paid out from the increase in debt.

All in all, one might think that those two issues might lead to a decrease of the valuation premium for Kabel Deutschland. Fat chance, because just by pure coincidence, the following story appeared in the Newspapers last week (before the other two events mentioned bacame public):

According to “insiders”, Vodafone is contemplating to take over Kabel Deutschland.

The reason seems logical: Vodafone needs to offer “quad play” services (Televison, Internet, fix line phone, mobile phones) and has already purchased in a similar fashion Cable and Wireless UK fixed line operations in 2012. So a clear no brainer.

Kabel Deutschland directly jumped more than 20% and the following bad news (Telecolumbus, 9 months earnings) were mostly ignored.

Vodafone Cable and Wireless UK acquisition

It is absolutely correct, that Vodafone acquired Cable and Wireless UK operations last year. However, what many “analysts” did not mention was the fact that Vodafone was very disciplined here.

When Cable and wireless split in two companies in 2011, there was always the rumour that Vodafone would be interested. However the waited a long time until the price was right before they came out with an announcement in April last year.

According to Bloomberg, Vodafone finally paid the following multiples:

P/S 0.3
EV/EBITDA 2.5
EV/EBIT 6.7

So Vodafone actually bought here at “rock bottom prices”. In my opinion, the days are over when Vodafone would move in and pay any price for Cable Deutschland.

In my opinion, there are also no other natural buyers for Kabel Deutschland. Liberty has already bought Kabel BW and will not be allowed to buy Kabel Deutschland. The big Telcos have enough problems already and for a PE buyer, Kabel Deutschland is already too “bootstrapped” to be interesting.

I am pretty sure that Vodafone knows that and will not rush into a Kabel Deutschland deal, if at all.

Conclusion

In my opinion, the “Vodafone Insider story” was a prime example of stock promotion, making the stock jump with a somehow plausible story and making people forget about the rather sobering underlying picture.

I am therefore once again, going to establish a short position in Kabel Deutschland, betting against a take over by Vodafone at a premium. As always with shorts, I will start with a 1% position.

At current prcies, I believe the risk/return ratio is quite good, as I don’t believe that Vodafone will buy at current prices (or even pay a premium) and there is a good chance that Kabel Deutschland’s valuation will approach average levels at some point in time.

Edit:
In my “home forum” benny_m posted a interesting link regarding potential cable regulation in Germany:

http://www.teltarif.de/kabelnetz-regulierung-bundesnetzagentur-homann/news/49249.html

That might be a game changer…….

Interesting short idea from Bronte (and a free course in forensic accounting): Focus Media (Chinese RTO)

For those who don’t read the outstanding Bronte Capital blog regularly, I can ony recommend: put it on your priority reading list.

After his not so well timed Richemont short, he has now set his eyes on Chinese company Focus Media from China.

Focus Media is a (on paper) fantastically profitable company from China wich was already subject of a Mudddy Waters report.

John Hempton has now a real series of very detailed posts about the company:

Read more

Portfolio updates & ManU short

Draeger Genußscheine

After the dramatic increase in the Draeger Genußscheine, the portfolio weight of this position increased to aropund 11%. As 10% is my maximum treshold, I will sell down to 10% of portfolio weight from today on.

Manchester United short

Manchester United is now avaliable to short at Interactive Brokers. Therefore I will start with a 1% portfolio weight short position as of today as discussed in the post.

On the third trading day, the stock showed already a similar pattern to Facebook after the IPO, with the banks supportiung now at 13,40 USD after the IPO price didn’t hold.

Rebalancing: Total Produce, Hornbach, Vetropack

Due to differences in performance and paid out , some of my core holdings dropped significantly below the 5% target thresholds, among others:

- Total Produce (~4.2%(
– Hornbach (~4.5%)
– Vetropack (4.16%)

For those 3 companies, I will add to a full 5% over the next days depending on volume.

DISCLAIMER

By the way, please do not forget that I might own or buy or sell the mentioned securities privatley and read the disclaimer.

Why is Michael Kors (KORS) so succesful ?

In this post I identified Michael Kors as a “Tier 2″ luxury stock with a really high valuation which might be an interesting stock to short based on my underlying thesis.

So justa few days later, Michael Kors reported a blow out performance, among oters:

Sales including licensing revenue rose 71 percent to $414.9 million in the first quarter ended June 30, driven by comparable-store sales and shops within department stores, the company said.

Retail net sales rose 76 percent to $215 million in the quarter, driven by a 37 percent increase in sales at stores open for at least a year, or comparable-store sales. The company opened 76 stores from the same period last year and operated 253 retail stores as of June 30.
First-quarter net income more than doubled to $68.6 million, or 34 cents a share, from $24.1 million, or 13 cents a year earlier.

First-quarter net income more than doubled to $68.6 million, or 34 cents a share, from $24.1 million, or 13 cents a year earlier.

So a doubling net income, 76% sales growth and a 37% yoy same store sales growth is really amazing if we look at how other upscale retailers do.

Interestingly enough, Michael Kors is not yet present in Asia, despite having the shares listed in Hongkong.

So the question is clear: Why is Michael Kors so successful (at the moment) ?

I guess one of the reasons is hs involvement in the US “Project Runway” designer casting show as a judge. However, the 10th series seems not to be too successful right now with viewers down 25%.

Kors’ Fashion is often described as the “Jet Set style”, whatever that means. His bio is not without bumps, for instance he went bankrupt in 1993 according to this article.

Michael Kor watches and jewelry are actually made by Fossil, which seems to have its own problems.

But still, why are they so successful ? I browsed around a little bit and among others I found statements

here:

What is the deal with the Michael Kors watch phenomenon? Everywhere I look there’s another small wrist encircled by an oversized gold Kors disc. Beauty PRs and fashion assistants absolutely love them, as do twenty-something city girls. “Girls that work in the city who want a Rolex. They might not know who Michael Kors is but they know they like shiny things,” tweeted @WhistlesPR in reply to my ‘who’s buying all the Kors watches’ tweet. “It’s chunky and looks expensive but it’s waaay cheaper than my dream Rolex! It has that magpie effect on everyone who clocks it,” confirmed @saraheangus.

With prices for Kors watches hovering around the £250 mark, they’re an easy entry-level accessory to buy into if you’re not in a position to spend £600+ on the bag or shoes. Clearly, plenty of people aren’t; according to the New York Times, sales of Kors watches went up 142% in the first quarter of this year. And good news for Mr Kors, his customers don’t just settle for one.

If one googles around, it seem to be really the relatively cheap watches which are extremely popular at the moment.

Balance sheet

Looking in the 2011/2012 annual report one can see that comparable sales growth per store have been 39% last year and even 48% the year before.

A quick check of the annual report showed nothing unusual in the accounts. Free cashflow generated is positive but relatively low due to large investments and the high growth rate. That’s normal. Also, goodwill is low and almost no financial debt.

Operating lease liabilities are around~ 560 mn and increasing due to the new stores.

Summary:

I am not sure why Michael Kors is so successful at the moment. This might be just a consumer fad which according to Jim Chanos might be a good short opportunity. On the other hand, the accounts look OK and currently in a “new normal” world, people pay up for growth.

So for the time being I will sit on the sideline and watch.

Manchester United IPO (MANU) – Prime short target ?

After unseccusfully trying Hongkong and Singapore, ManU Ipoed today on the US stock exchange. The IPO price was significantly below the initial range:

The IPO priced at $14, below the $16-20 range the club’s bankers had been seeking. It valued the 19-times English champions at only $2.3 billion and shaved as much as $100 million off the proceeds expected for the team and its owners.

Of course, the public shares have almost no voring rights and dividends should not be expected.

For anyone interested in stocks and football, the F-1 listing prospectus is really fun reading and should not be missed.

Valuation is relatively difficult to determine, but somewhere in the 20-25 EV/EBITDA range based on 2011 figures. Naturally, Manu has been pumped full with high yielding debt from its P/E owners and has additional “goodies” such as 140 mn USD “purchase obligations” etc.

Interestingly they file under the “Emerging Growth” company rule, which allows corporate governance similar to my beloved Italian highway operators….

A quick look at other listed Football clubs:

By the way, Porto could be bought for only 5 mn EUR…..

Yes, ManU is a great Football club, but they cannot and will not defy gravity. So prime short candidate if borrowing is available. It is not yet oin the Interactive Broker US short list, but as soon as it is there, I wil establish a position.

Shorting Luxury stocks – Follow up

So shorting luxury stocks is not easy. I mentioned Bronte’s Richemont short in the previous post. Howver, Richemont issued very strong numbers with no slow down detectable. The same seems to be true for Prada:

Italian fashion house Prada SpA (1913.HK), which competes with Louis Vuitton (LVMH.PA) and PPR’s (PRTP.PA) Gucci, posted a 36.5 percent jump in first-half revenue, buoyed by strong growth in Asia, with sales driven mainly by its Prada and Miu Miu brands.

Revenue for the six months ended in July rose to 1.55 billion euros ($1.9 billion), the Milan-based maker of luxury bags and clothing said on Monday.

John Hempton reacted pretty quickly but seems to be confused.

One alternative explanation of Richemonts numbers comes from the WSJ:

“China’s outbound tourism industry has boomed in recent years, helped in part by the allure of luxury goods overseas.”

So with a relatively cheap Euro, Chines Mainlanders might not fly to Hongkong but straight to Europe to shop for their Richemont Watches and Hermes bags. Just on the week end I was astonished by the long queue of Asians on the Munich Airport waiting for their sales tax refund.

My current thesis for shorting luxury stocks is the following:

- the ultimate top level luxury brands like Hermes etc. will suffer less from a slow down as the very rich will keep on spending, no matter what
– tier 2 brands, those who get bought by the upper middle class will suffer more as those guys will have to cut back quicker and harder in a crisis
– companies who expanded their own sales network rapidly in the last few a lot will get hit harder than companies which don’t run own outlets.

So the focus should be on “tier 2″ luxury brands with a lot of retail exposure (operating leases) and weak balance sheets. Preferrably, store growth should have slowed done already, or maby some store closings should have already happened.

So lets look at a list of luxury/high end retailers. For fun I included Nike, Adidas and Piquadro as well to look how they compare:

Name
Tier 1
PRADA S.P.A.
CHRISTIAN DIOR
HERMES INTERNATIONAL
LVMH MOET HENNESSY LOUIS VUI
PPR
BURBERRY GROUP PLC
TIFFANY & CO
SALVATORE FERRAGAMO SPA
CIE FINANCIERE RICHEMON-BR A
Tier 2
PIQUADRO SPA
BRUNELLO CUCINELLI SPA
ADIDAS AG
NIKE INC -CL B
SAMSONITE INTERNATIONAL SA
TUMI HOLDINGS INC
TOD’S SPA
RALPH LAUREN CORP
COACH INC
MICHAEL KORS HOLDINGS LTD
HUGO BOSS AG -ORD

The Tier 1 /Tier 2 classification is a totally subjective classification from my side.

So to add some “meat” to this, lets look at some “raw” valuation metrics:

Name EV/EBITDA 2012 P/E P/B P/FCF
Tier 1        
PRADA S.P.A. 15.5 34.7 8.3 65.9
CHRISTIAN DIOR 6.1 15.1 2.2 9.8
HERMES INTERNATIONAL 19.7 39.0 10.0 40.5
LVMH MOET HENNESSY LOUIS VUI 10.5 19.0 2.8 30.7
PPR 9.8 15.2 1.4 24.8
BURBERRY GROUP PLC 10.4 21.9 6.7  
TIFFANY & CO 8.4 15.7 3.0  
SALVATORE FERRAGAMO SPA 12.8 34.3 13.2 34.7
CIE FINANCIERE RICHEMON-BR A 9.6 17.4 3.0 26.4
Tier 2        
PIQUADRO SPA 5.5 9.0 2.7 10.9
BRUNELLO CUCINELLI SPA 17.3 34.3 19.1 67.4
ADIDAS AG 8.9 16.6 2.3 17.3
NIKE INC -CL B 11.3 20.0 4.2 33.6
SAMSONITE INTERNATIONAL SA 8.1 26.3 2.6 85.3
TUMI HOLDINGS INC 21.2 42.7 43.9  
TOD’S SPA 9.1 17.4 3.4 26.4
RALPH LAUREN CORP 9.9 20.8 3.8 22.7
COACH INC 8.4 15.5 7.9 16.0
MICHAEL KORS HOLDINGS LTD 19.9 38.0 18.1  
HUGO BOSS AG -ORD 10.9 17.4 11.9 29.8

One can see clearly that in the “Tier 1″ category, Prada and Hermes stand out in terms of valuation, but also they are outstanding premium brands.

In “Tier 2″, especially the new IPOs, TUMI, Michael Kors and Brunello look expensive, especially I highly doubt that those brands are even close to the long term value of a Hermes or Prada brand.

Some additional infos in the next table:

table.tableizer-table {border: 1px solid #CCC; font-family: Arial, Helvetica, sans-serif; font-size: 12px;} .tableizer-table td {padding: 4px; margin: 3px; border: 1px solid #ccc;}
.tableizer-table th {background-color: #104E8B; color: #FFF; font-weight: bold;}

Name Future Minimum Operating Lease Obligations LF Revenue T12M Lease/revenue Debt/EBITDA LF
Tier 1        
PRADA S.P.A. 1,318,771,727.17 2,212,724,598.94 59.6% 0.5
CHRISTIAN DIOR 4,499,997,166.86 23,185,601,928.23 19.4% 1.4
HERMES INTERNATIONAL   2,465,950,626.43   0.0
LVMH MOET HENNESSY LOUIS VUI   22,261,439,383.88   1.3
PPR   9,599,553,313.27   2.8
BURBERRY GROUP PLC 640,300,032.00 1,857,200,000.00 34.5%  
TIFFANY & CO   2,327,788,295.92   1.0
SALVATORE FERRAGAMO SPA   856,156,635.81   0.6
CIE FINANCIERE RICHEMON-BR A 1,194,736,463.41 7,644,616,343.90 15.6% 0.4
Tier 2        
PIQUADRO SPA   55,621,116.76   0.9
BRUNELLO CUCINELLI SPA   210,603,043.70   1.4
ADIDAS AG   12,125,170,682.01   1.2
NIKE INC -CL B 1,386,834,706.54 15,181,364,342.46 9.1% 0.1
SAMSONITE INTERNATIONAL SA 129,442,413.07 976,677,821.80 13.3% 0.0
TUMI HOLDINGS INC 0.00 228,242,106.47   4.5
TOD’S SPA 250,946,920.20 775,643,994.46 32.4% 0.3
RALPH LAUREN CORP 1,227,233,677.46 4,301,242,776.32 28.5% 0.2
COACH INC   3,010,310,037.06   0.0
MICHAEL KORS HOLDINGS LTD 335,036,357.76 770,199,265.10 43.5% 0.0
HUGO BOSS AG -ORD   1,867,480,409.77   0.8

I tried to gather some data regarding debt and leases. Although I have not filled all the blanks, it looks like TUMI has quite a lot of debt, whereas Michael Kors has some serious lease obligations.

So those two might be interesting short candidates. Although for Tumi, Short interest is already ~37% of float…

To be continued….

Idea generation: Shorting Luxury stocks

This is an idea which I am contemplating for some time.

Coneventional stock market wisdom says: Chinese / Asians love luxury goods, therefore this is the safest bet to buy Luxury stocks who sell to the Chinese consumer.

As a result, many luxury companies had great runs intheir stock price, for instance:

LVMH

Boss

or Ralph Lauren

However up until now, I did not really no where a “catalyst” would come from. So switch to the brilliant John Hampton at Bronte who really nails it down with Richemont, the Swiss luxury group:

Swiss Watch exports have been increasing, as the Chinese really dig expensive watches:

It is the Rococo stuff that is winning. The Federation of the Swiss Watch Industry publish export data from Switzerland (not sales to end consumers). June data shows a 4.1 percent reduction in volume, a 21.7 increase in value. The average price of a watch is going up sharply. This has been the case for years. The Federation published this graph which shows that (relatively accurate) electronic watches have been flat in value for years – but that mechanical movements (inaccurate but reassuringly expensive) have gone skyward:

Although exports to Hong kong are still increasing strongly, sales seem to have stalled:

There are several data sources I watch to keep tabs on spending by Chinese elite. The Swiss Watch data is obvious.

Exports to Hong Kong in June were up 21.2 percent. It was about the same in May (but the monthly data has disappeared from the web). It was about the same every other month this year. They keep upping the exports to Hong Kong.

But Hong Kong also has sales tax data which comes from the sales tax receipts. There is in the data a series for “Jewellery, watches, clocks and valuable gifts” by both value and volume. The value series – relatively flattering, has monthly sales (versus previous corresponding period) for the last six months as:

+18.3%
+14.1%
+18.4%
+15.1%
+2.9%
+3.1%
Sales growth stopped. However exports to Hong Kong kept up (note that 21.2 percent figure above).

John Hempton is not a guy who would short such a share because of date, he needs a real reason and this is the following:

have a theory given to me by a China watcher. The theory – it turned bad sharply with the ouster of Bo Xilai and now the murder charge on his wife Gu Kailai. Gu Kailai is going to have a hard time avoiding a mobile execution unit. This changes the stakes and it is structural. A half million dollar watch no longer says “look at me”. It says “look at me, I am a kleptocrat”. Thoughts of that beautiful Van Cleef and Arpels hair clip become the last thing that runs through your brain before the bullet.

And he can prove his theory with the example Brazil in the 80ties and 90ties:

We know what a completely collapsed luxury good market looks like. Brazilians like a bit of bling. But in the late 1980s and into the 1990s the kidnapping rate in Brazil went skyward. (There is an horrific documentary about that called Manda Bala which translates “send a bullet”.) After kidnapping became a major industry (particularly in São Paulo) carrying a $3000 handbag no longer said “look at me”, it said “kidnap me”.

Two other data points in the recent weeks show that maybe the Chinese consumer might be (for any reason) a little biut more cautious:

- Sales at Sand’s Chinese casinos disappointed strongly

- and even McDonalds announced that same store sales in China fell

For me, such company news are much more reliable than any Chinese Government statistics.

Let’s quickly look at Richemont:

The stock price ist still below its 2008 highs:

The stock doesn’t look so expensive either:

Trailing P/E 16,6
P/B 2.8
P/S 2.9
EV/EBITDA 9

is not that expensive for a stock with a 17% profit margin and 20% ROIC, a very conservative balance sheet with no goodwill and net cash. Even mean reversion would support current levels. 10 year average net margin is 20%, only 10 year average ROIC is “only” around 10%.

A much more interesting short candidate might be Boss.

Boss is more expensive

Trailing P/E 17.3
P/B 11.9
P/S 2.4
EV/EBITDA 11.5

and 10 year avg. profit margin is 8.6% against current 13%.

Still, I would prefer to short luxury shares with aggressive accounting, but I have to dig a little bit deeper for this.

And do not forget: Luxury sales in Europe are bad anyway and as Coach shows, even the US is not “an island” with regard to luxury sales.

Summary:

I guess shorting Luxury stocks might be an interesting idea at some point in time. I wouldn’t short Richemont, as this is really one of the rock solid companies, but other candidates might be more interesting. Preferably with aggressive accounting and US / Europe exposure.

Digging deeper: Short interest and stock performance

In my last post about potential short candidates, I said:

Personally, I would hesitate to short anything above a 15%-20% percentage of SI/Free float although I have no “hard knowledge” to support this.

In the comments, Winter correctly pointed out that one could also argue the other way around, the higher the short interest, the higher the possibility that the stock will drop.

Interestingly, for many trades, stocks with high short interests seem to be attractive long opportunities as pages like this show.

To quote them:

Stocks with high short interest are often very volatile and are well known for making explosive upside moves (known as a short squeeze). Stock traders will often flock to such stocks for no reason other than the fact that they have a high short interest and the price can potentially move up very quickly as traders with open short positions move to cover.

Googling around a littel bit I found the following interesting paper called Short Interest and Stock Returns

The introduction starts of supporting Winter comment:

It is now widely accepted that stocks with high short interest ratios underperform the market. This is a very recent bit of conventional wisdom, based largely on the evidence in Asquith and Meulbroek’s (1995) unpublished working paper for New York Stock Exchange (NYSE) and American Stock Exchange (Amex) stocks, and Desai, Ramesh, Thiagarajan, and Balachandran’s (2002) article for Nasdaq stocks. Both Asquith and Meulbroek and Desai et al report negative and significant abnormal returns for firms with short interest ratios of 2.5% or more, where the short interest ratio is defined as the ratio of short interest to shares outstanding. Both papers also report large secular increases in short interest ratios, and skewed cross-sectional distributions, with most stocks having short interest ratios of less than 0.5%, and very few firms having a ratio exceeding 10%. Prior to these papers, the conventional wisdom was that large short positions presaged positive future returns, caused by the flow demand from short sellers covering their positions

The paper is worth a read. In general, the authors confirm that stocks with high short ratios seem to underperform:

Consistent with other studies, we find that the higher the short interest ratio, the lower is the subsequent performance. That is, firms with short interest ratios of 10% or more underperform those of 5% or 2.5%.

Their research shows that the effect is not so significant as previously thought and that it only works for equal weighted portfolios, not for market cap weighted portfolios.

They paper also gives a good overview of ohter papers on this topic, it seems to be that this area is not as well researched as others.

Their results can be summarized with this quote:

We find that the underperformance of high short interest firms is fairly brief, and only rapid portfolio turnover allows us to realize this underperformance. We also examine whether high short interest is based only on valuation concerns and find that convertible bond arbitrage is a major reason for high short interest as well. Finally, we show that the performance of high short interest NYSE-Amex stocks is more severe and consistent than for their Nasdaq 24 counterparts over the period July 1988-2002, and that small cap firms make up a large portion of the firms that are highly shorted.

Howver they question if a such a strategy can be effectively implemented especially as the overall universe of high short interest stocks is relatively small.

One aspect is missing in the paper in my opnbion : As far as I could see they did not explicitly incorporate volatility of returns. So the outperformance could be just the effect of a much higher volatility of those shares.

However as a first summary, I will have to rethink my gut feeling to stay away from stocks with high short interest.

It might make also sense for short idea generation to use those short interest tables, especially AMEX/ NYSE stocks.

Currently the NYSE page from the link mentioned above shows the following top 20 NYSE stocks with high short interest:

TEA Teavana Holdings, Inc. NYSE 60.04% 8.81M 38.31M Retail (Grocery)
HGG hhgregg, Inc. NYSE 54.35% 17.26M 37.24M Retail (Technology)
BPI Bridgepoint Education Inc NYSE 53.93% 17.23M 52.21M Schools
BKS Barnes & Noble Inc NYSE 49.68% 38.38M 60.20M Retail (Specialty Non-Apparel)
GME GameStop Corp. NYSE 49.46% 131.18M 133.98M Retail (Technology)
KBH KB Home NYSE 47.06% 65.44M 77.10M Construction Services
SVU SUPERVALU INC. NYSE 41.95% 210.68M 212.26M Retail (Grocery)
ESI ITT Educational Services, Inc. NYSE 39.67% 24.44M 24.75M Schools
OSG Overseas Shipholding Group Inc NYSE 38.20% 23.27M 30.45M Water Transportation
MCP Molycorp, Inc. NYSE 37.87% 56.05M 96.40M Metal Mining
RSH RadioShack Corporation NYSE 36.41% 98.46M 99.43M Retail (Technology)
CRR CARBO Ceramics Inc. NYSE 35.98% 19.73M 23.09M Oil Well Services & Equipment
USNA USANA Health Sciences, Inc. NYSE 35.81% 6.17M 14.99M Personal & Household Products
ONE Higher One Holdings, Inc NYSE 34.55% 32.64M 56.81M Schools
SAM Boston Beer Company, Inc., The NYSE 34.14% 8.40M 8.79M Beverages (Alcoholic)
AM American Greetings Corporation NYSE 33.79% 34.51M 35.54M Printing & Publishing
GDP Goodrich Petroleum Corp NYSE 33.26% 26.03M 36.37M Oil & Gas Operations
URI United Rentals, Inc. NYSE 31.78% 63.05M 63.77M Rental & Leasing
CJES C&J Energy Services Inc NYSE 31.63% 39.07M 51.89M Oil Well Services & Equipment
FIO Fusion-IO, Inc. NYSE 31.15% 49.59M 90.12M Computer Hardware

Some of those stocks even show up regulary on value blogs. So another application of such lists could be to even more scrutinize “value stocks” with high short interest as they might be potential value traps.

A final word on European stocks: Unfortunately, the disclosure of short interest in Europe is close to non-existent. Also, as the Volkswagen example showed, “cornering” is still an issue with European stocks. So in any case one should be extra carefull with single stock shorts.

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