Owning a stock that is a target of short-sellers can be an excruciating experience for shareholders.
An earnings downgrade or even just a case of market jitters can trigger a sharp decline in stock prices within minutes.
We've seen it recently with Metcash Limited (ASX: MTS), and Slater & Gordon Limited (ASX: SGH) with both companies among the most-shorted stocks on the ASX. It's no coincidence that they're substantially down for the year.
Now, Fairfax media is reporting that a number of other companies are experiencing a drastic rise in 'short' interest, although the targets seem a little incredible.
SEEK Limited (ASX: SEK), Carsales.Com Ltd (ASX: CAR), and REA Group Limited (ASX: REA) are all firmly in the sights of short-sellers in the lead up to reporting season, with hedge funds apparently predicting underwhelming results.
According to documents filed with the Australian Securities and Investment Commission (ASIC), daily short interest in these stocks recently stood at 2.7% for REA, 5.59% for Carsales, and 7.57% for SEEK. By way of comparison, short interest in Slater & Gordon was around 8% before that company fell 20% in a single week in June.
How it works
Short sellers take advantage of market uncertainty and/or disappointing results to profit when a stock is on the way down. They borrow stock to sell at a high price, buy it back at a lower price and pocket the difference.
A falling stock is required for this to be effective, but short-selling can often prolong or exaggerate a fall beyond what would normally be expected. When investor sentiment is already negative – primed to expect the worst – the effects can be magnified.
Why they're at risk
SEEK Limited appears the most vulnerable to short sellers after the recent earnings downgrade for its SEEK Learning division generated negative sentiment for the company. It could be that short-sellers are expecting its overall full year results to disappoint further (or simply to be not as good as investors are used to), which could be the catalyst for further falls.
Carsales.Com and REA Group have also experienced their own falls in recent times as investors were disappointed with earnings updates, despite the fact that both results were little short of extraordinary.
The trouble is that SEEK, Carsales and REA are all priced for substantial success with Price to Earnings (P/E) multiples of 25 or higher, which means they can be downgraded even if growth simply fails to meet the levels delivered in recent years.
Certainly with such high short interest, Carsales and SEEK in particular are vulnerable to a savage sell-off if they disappoint in reporting season.
Long-term investors know a bargain when they see one however, and each of these three companies – already a great deal – will become that much more appealing if the short-sellers strike.
