INVESTOR EDUCATION – Short Selling
Investors that buy a stock, acquire the shares in hope that they are able to sell the stock at a higher price
sometime in the future and lock in gains.
Short selling is the opposite of buying a stock. An investor sells the share today in hope that they can buy
it back in the future at a cheaper price and therefore make a profit.
Two key differences between buying and selling a stock are
1. To sell a share short, you need to be able to borrow the stock
2. When you short sell a stock your downside (potential loss) is unlimited, while
your upside/profit is capped to the amount that the current share price goes
to zero. When you buy a stock, the opposite is true. Your upside is unlimited
while your downside is capped to the amount you originally invested
Below is a table holding the 5 of the most shorted stocks on the ASX.
Given that short sales signify that some investors think the price of the stock will
decline in the future, it suggests that there are some underlying economic reasons
that these short sellers think the share price is currently overvalued.
However, short sellers are not always right. If the company is actually in a far better
position than the short sellers have anticipated, then eventually more investors will
buy the stock which is likely to cause the price to rise and force the short sellers to
cover their position. In order to do this, the short seller must enter the market and
repurchase the shares that they previously sold and by doing so creating further
demand for the stock.
In this way there is potential for large gains for longer term investors who bet that
the company is able to turn their current misfortunes around.
Is short selling bad for markets and investors?
Short selling in theory is not bad for markets. It arguably leads to an efficient market
where price equilibrium is obtained more quickly. They help to prevent shares prices
valuations become unrealistic and consequently creating stock market bubbles.
However, short sellers can also cause a lot of problems for the listed companies. By
short selling the stock they may be able to influence other investors into selling
despite there being little reason to. This can create panic and investors lose confidence in the stock. However, there may be little or no fundamental reason to do so.
In this way, large hedge funds and fund managers can “bully” smaller investors into
selling as they see the share price falling and decide to sell on price reaction rather
than any fundamental reason. Small investors need to protect themselves by arming
themselves with knowledge and ensuring that they have a strong understanding of all
factors, both good and bad, of why the stock price is moving.
assess the rational and outlook for the ASX’s 10 most shorted stocks.
MONADELPHOUS GROUP
Background:
Monadelphous Group is an engineering company. It is the leading structural and
mechanical contractor in the resources market in Australia. It has a particular focus
on the Western Australian iron ore industry. The company also provides construction,
maintenance and industrial services to the resources, energy and infrastructure
sectors across Australasia.
Rational for short:
Monadelphous currently generates 70% of its revenues from the Oil & Gas and Iron
Ore industries. With commodity prices near multi year lows given supply and demand
imbalances and Australian capex intentions of industry participants remaining
negative, many are betting the company will continue to perform poorly.
As a result revenues have come under significant pressure and consequently so have
company profits.
’s outlook: Neutral
The current operating environment remains challenging for the company and until
commodity prices recovery the company’s earnings will remain under pressure.
The company is particularly cheap on a forward P/E basis and is at the lower end of
its historical range. If industry capex intentions turn positive, it could have a material
impact on the company’s revenues and bottom line. However for this to happen, we
would need to see a material recovery in global material prices. believes that
although a bottom has been established in most commodities, it may take some time
before supply/demand imbalances abate.
MYER HOLDINGS LTD
Background:
Myer Holdings is a department store group offering fashion and apparel for men,
women, and children; accessories; cosmetics; homeware; furniture; electrical goods;
and general merchandise. MYR is rapidly implementing an omni-channel (a multichannel approach to sales that seeks to provide the customer with a seamless shopping experience) strategy to counter online competition.
Rational for short:
Myer has suffered in challenging trading conditions as the company struggles to
compete with the globalisation of retail which has seen international retailers with
strong brand awareness commence operations in Australia, in addition to consumer
preferences shifting to online sales.
’s outlook: Positive
Consumer conditions are currently very accommodative. Interest rates are set to
remain low for the medium term in addition to low fuel and cost inflation. This should
translate to an increase in discretionary income for consumers over the near term.
Naturally, major retailers such as MYR should benefit from the increased consumer
spending which should provide further uplift to the company’s sales growth.
Management has undertaken a fundamental overhaul to address the major
inadequacies inherent in the existing business. We believe that management can
make significant inroads to adapting to the evolved environment particularly as
economic conditions become more consumer friendly.
PRIMARY HEALTH CARE
Background:
Primary Health Care is the largest medical centre operator in Australia and the second
largest pathology provider. Primary Health Care operates in four segments: Medical
Centres (~19% of sales), Pathology (~56%), Imaging (~22%), and Health Technology
(~25%).
Rational for short:
Unfortunately, companies operating pathology and imaging clinics have run into a
huge roadblock in recent times, which has already proven costly to their revenues
and bottom line figures.
The Federal Government is conducting a review into the Medicare Benefits Schedule
with the aim to reduce spending on healthcare it deems to be unnecessary for
taxpayers. This is likely to have a major negative impact on Primary Health Care
revenue stream.
’s outlook: Neutral
While healthcare is typically an attractive industry to be in given the defensive nature
of the industry and the ability to benefit from a growing and ageing population, it’s
also highly regulated and subject to government funding.
It is fairly unclear exactly what shape or form the new regulation from the Federal
Government will take. Accordingly it is difficult to have a view on Primary Health Care
with any conviction.
WORLEYPARSONS LTD
Background:
Worley Parsons provides engineering procurement and construction management
services to the resource and energy sectors. It covers the lifecycle from creating new
assets to sustaining and enhancing operating assets, in the hydrocarbons, minerals,
metals, chemicals and infrastructures sectors.
Rational for short:
Worleyparsons depends heavily on the oil and gas industry – roughly 72% of revenues
comes from that sector, with 12% from resources and the remaining 16% from
infrastructure projects. Given the plunge in oil prices over the course of the past 1.5
years, Worleyparsons profits have come under a considerable amount of pressure.
’s outlook: Negative
We believe the long term outlook for hydrocarbons capex is challenging. We
anticipate the oil majors to scale back their medium to longer term capex plans in the
interests of capital discipline and shareholder focus amidst a lower oil price
environment. This is ultimately a negative for the company’s future prospects and
therefore a negative for its bottom line.
Further, we believe that earnings risk and low earnings visibility will remain a key
issue for the company. believes that although a bottom has been established in
most commodities, it may take some time before supply/demand imbalances abate.
However until that time, risk remain around potential project deferrals and
cancellations.
CABCHARGE AUSTRALIA
Background:
The Company operates in Taxi related services and Bus & coach services segments. It
provides taxi network services to taxi operators and drivers, and provides booking
and dispatch services. The Company operates over 7,000 taxis in Sydney, Melbourne,
Adelaide and Newcastle and provides an alternative to cash payments for over 90%
of Australia’s taxis.
Rational for short:
The industry is undergoing substantial change as competition from new mobile app
booking technology replaces competition from second terminal providers. The company has lagged in technology advancements which has led to major market share loss.
Competition has significantly impacted on the company’s revenues and it is
questionable whether Cabcharge is able to keep pace and challenge the new entrants
to the industry.
The stock sits near a 13 year low and has lost nearly half of its value in the last 18
months
’s outlook: Negative
Cabcharge’s industry appears to be very saturated and as such competition remains
high. We don’t see any particularly compelling reasons why Cabcharge will be able to
materially increase its market share.
Accordingly, Cabcharge’s revenues and therefore profits are likely to remain under
pressure. Despite trading on a relatively low P/E basis, it is questionable what the
quality of the company’s earrings and whether they are sustainable.
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