The US reporting season has gotten off to a poor start and the Australian reporting season might not fare much better if the latest short-selling data is anything to go by.
The latest figures from the Australian Securities and Investments Commission (ASIC) show that 30% of ASX-listed companies have experienced an increase in the number of their shares being short sold over the past month, while only 20% enjoyed a reduction in shares being short sold.
This should be a red flag because research has shown that a material increase in short interest over a short period is a precursor to underperformance and could highlight stocks that will disappoint the market during next week's reporting season.
Short selling refers to traders selling stock they have borrowed in the hope of buying it back later at a lower price to profit from the difference.
The value of short positions ahead of the August profit season has hit $22.9 billion, which is more than 50% above the same period in 2014 and 2013, according to Morgans.
The group went on to say that stocks that have experienced a 200 basis point (2 percentage points) increase in the number of shares being short sold tend to lose close to 10% of their market value over a one-month period, while those that experience a 100 basis point increase in short interest have shed 4% of their value over the same period.
So which are the stocks that short sellers are expecting to bomb out when they turn in their report cards? ASIC data is always a week old but based on what's available, taxi payment and bus services group Cabcharge Australia Limited (ASX: CAB) tops the list (ignoring resource companies) as the percentage of its shares that have been short sold has jumped 360 basis points to 11.1% in the past month.
Cabcharge is the seventh most shorted stock on the market as it struggles to grow earnings after it lost its taxi payment monopoly following an adverse ruling by our competition watchdog.
A lot of bad news has been priced into the stock since it shed 27% of its value since January and it may well be a "sell the rumor-buy the fact" kind of stock if its share price bounces on the release of its full year result.
Enough has been written about its big price-earnings discount to the market with the stock trading on a 2015-16 consensus forecast P/E of around 7x.
But using P/E benchmarks to value this stock is a mistake. The problem is that analysts are expecting profits to keep sliding in the current financial year, which would mark its third straight year of profit decline.
This means the stock will just keep getting more expensive as time goes on and Cabcharge can only enjoy a re-rating if it can convince the market that it can stem the earnings decline. That might be tough given the threat of ride sharing service Uber.
I would avoid Cabcharge just on this last point alone.
Law firm Slater & Gordon Limited (ASX: SGH) is another that is predicted to disappoint come August. Short interest in the stock has jumped 285 basis points in the past month and 690 basis points over a three-month period.
Just over 10% of Slater & Gordon's stock has been shorted but choosing how to play the stock is much like flipping a coin as it's anyone's guess if its accounts can be believed since ASIC started investigating the company.
My colleague Mike King has written about why you should stay away from the stock and you can read it here.
Let's hope the reporting season will be kind to the rest of the market.
