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 This is a very recent bit of conventional wisdom, based largely on the evidence in Asquith and Meulbroek’s (1995) unpublished working paper for New York Stock Exchange (NYSE) and American Stock Exchange (Amex) stocks, and Desai, Ramesh, Thiagarajan, and Balachandran’s (2002) article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.

11 comments

  • I disagree on Overstock but I leave it there.

    The reference to dubious characters (like Gray Weiss) implied by the Overstock short thesis you were referring to made me write the comment. The Antar article lacks substance, too (where are the accounting tricks, etc?…).

    These two guys promote a smear campaign on Overstock. For that reason I did not expect Overstock to be mentioned on your blog.

    But indeed it was not a full analysis on your part. Your blog is good quality.

    Best wishes

    • No problem and thanks.

      To give Antar some credit, he is “smearing” other companies as well and his Green Mountain comments were “spot on”.

      But as with every other source, before I invest I will always do my own homework.

      MMI

  • Dear M,

    Your blog is great. I wanted to share my view on Overstock which coincides with this author’s opinion (http://www.gurufocus.com/news/168976/overstock-is-unbelievable–in-a-good-way).

    Grumpy Old Accountants:
    – where is the analysis? Accounting tricks? Is Z-score relevant here? (http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/569#more-569)
    – red flag – The authors might consider being a wee more careful before associating their names with the likes of Gary Weiss.

    It would be nice if you would have a look YOURSELF at OSTK and share YOUR view with the blog’s followers

    Best

    • Dear Gusto,

      if you have read to post you might have noticed that this was about short idea generation. Idea generation does not need to involve a full analysis in the first step.

      The link I posted was wrong, actually i meant WhiteCollarFraud. I am following this quite a while und you can see clearly red flags averywhere

      Honestly speaking, the GuruFocus article is quite shallow. If the author didn’t care to dffferentiate between gross and net recording of sales then I would highly doubt any of his conclusions.

      Honestly, I don’t care to much about Overstock.com as I am not planning to do anything with that stock.
      MMI

  • Natürlich nicht… 😉 Die Kosten liegen je nach Region im mittleren 5stelligen GBP Betrag. Die Daten sind beispielsweise vollständig in FactSet (http://www.factset.com) integriert…

    Hanne

  • Hanne,

    die Daten sind aber nicht frei zugänglich, oder ?

    MMI

  • Hi,

    tatsächlich sind die Informationen auch für das europäische Analgeuniversum im Bereich institutionelles Short Interest relativ gut: http://www.dataexplorers.com/. Diese Daten sind im Gegensatz zu Bloomberg nicht 20 sondern lediglich 2 Tage alt…

    Hanne

  • Another aspect to consider is the repo you pay for borrowing shares. Repo is pretty high for many of the stocks you have been mentioning in your prior articles. Checking with two brokers (IB / GS), Zynga for example sports a hefty 35% annual borrow rate. There is a causal relation between short interest and borrow (obviously, as the # of shares in margin accounts are finite and hence supply tends to stand while demand increases). I therefore suspect there is no mispricing in high SI stocks as one cannot arbitrade the negative alpha.
    Some Chinese frauds actually had repos of >100% / year which meant that you had to bet the comp goes bankrupt within a year or you lose. funny.

    For what it’s worth: I ran into cases where bid-side call option premia were incredibly low as to incorporate repo in option prices. There, it made no sense to short the call as you captured almost no vola decay.

    • Ok, that is a severe problem (besides the volatility) for the short investor. But not for the long investor – low performance and high volatility is something to avoid (well, except, if the price fluctuation is only in upward direction).

      • Winter,

        exactly, I think the application for long contrarian invetsments might be the most important one out of these findings.

        Avoid cheap stocks with high short interest…

        MMI

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