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
- To sell a share short, you need to be able to borrow the stock
- 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.