Over the past month, our short plays have started to pay in spades, and nearly all of the stocks in our short database have dropped from their prior highs. With that said, there are still some extraordinarily expensive stocks in this market that wise, value oriented short sellers should consider "betting" against if the stock markets remain weak. Remember that around 70% of a given stock's shorter term movement is related to the overall direction of equity markets.
Although "timing" the market is difficult, we find adding a trend following/macro overlay to solid fundamental analysis works well when applied to the long/short investment space. In addition, we try to use options to play the short side by selling at the money or slightly out of the money call options against names we are bearish on to give the portfolio a margin of safety when we make "value investments in reverse."
Right now, we are pretty much fully hedged in stocks as we feel that value can be had here in deep value low price to book stocks while hedging against a broader equity market sell-off using Russell 2000 put spreads and short call options against overvalued, sketchy names. Here are ten stocks which I am short already or will be looking to short this week for my small hedge fund using short call options or in the money put options, and an explanation of why I am bearish or short on these names. We have taken profits on some of the stocks in our short book in individual names like Baidu (BIDU) (we got bearsh at $150), Sina (SINA), Yoku.com (YOKU), Rediff.com (REDF), LinkedIn (LNKD), and are looking to short stocks that have not yet fully broken down but which remain, in our view, markedly overvalued.
Keep in mind that we will exit our positions if we test the 200 day moving averages and bounce significantly off of the lows here -- the market is quite oversold but the fundamental reasons behind crashing equities remain (overvaluation, macro economic weakness, and the end of QE2). When going short, we usually look for popular, leading growth stocks that fetch bubble-like valuation and try to short them only once the overall markets have cracked lower and we try to scale or pyramid into these positions as they become profitable. Cutting losses quickly on the short side is always a good idea as the amount of money one can lose is theoretically infinite. That said, some of the froth we have seen in recent months certainly displayed many of the hallmarks of a typical equity or confidence bubble. Keep an eye on the oversold RSI, on the overly bearsih AAII Sentiment Survey, and on the 200 day moving average for a buy signal on overall markets and prepare to cover in order to stop losses if the market starts a significant bounce, which I will still be viewing as a dead cat bounce given the coming end to QE2.
(CRM) -- Salesforce.com is trading at nearly 300X earnings. The recent announcement that the government will be using their services seems at odds with the latest hacker troubles and the fact that Cloud Computing seems much more vulnerable to IP security risks than maintaining internal servers and database hardware. CRM is down a bit from recent highs which failed to break meaningfully above previous highs at around $152 per share. The stock looks too expensive here and investors looking to hedge existing long positions could consider selling out of the money near month call options on Salesforce, which is an expensive name that is still 300% above it's early 2009 price. I.e. the company is in a growth market but the stock has come too far too fast.
LNKD -- Linkedin has dropped substantially since we started our short sale coverage of the name at $110. If you Google "LNKD short" you can see our article recommending shorting the stock at $110 per share. We don't always get these right, but the risk reward is still on the side of the bears and not the bulls here given the stock's 1000X earnings valuation. Certainly, the high user base and daily traffic of LNKD is bullish for the company but the longer term issue investors face is whether or not traffic will translate to net profits quickly enough to justify the current price of the stock. I do think LNKD is a risky short and also that the cost to borrow these shares for a short is too expensive at 40% per year to make much sense. Therefore, we could prefer selling call options against the name at the $80 or higher strike prices.
(NFLX) -- Netflix is a great company but likely not a good long term investment at current prices. In our view, NFLX is a highly speculative play because the Blu Ray market is actually growing despite all of the bad press and because NFLX is betting the farm on streaming. Streaming faces huge challenges as content providers clamp down on pricing as the $8 per month all you can stream prospect significantly devalues the Studios main product. Box office sales have sunk this year likely because movie makers can't justify producing big budget films when the only winner from this move is Netflix and Redbox. The film industry relies on the economics of the home entertainment market and it is clear that a physical model is best for the studios over the long run. In other words, without Blu Ray the box office suffers and without the box office there really is no business model which makes any sense for movie studios. In the end, Netflix is in many ways a victim of it's own growth rate. In six months, the company's Starz deal will be over and in my view the streaming business will face a ton of pressure on a pricing basis. If analysts are diligent they can see that much of the growth in NFLX's cash flows have come from increases in short term liabilities. In fact, NFLX's leverage ratios have increases substantially in the past few years so the share buybacks and bets on streaming are truly an all or nothing proposition, and in our view we would lean with the nothing crowd over the "all in" proposition of investing in NFLX common at 72X earnings.
(BXP) -- Boston Properties is a stock that has truly defied gravity over the past few years. In Florida, where I am currently, home buyers can find properties for sale for 75% below their 2007 values. In contrast, BXP common stock has actually risen! Meanwhile, home prices are still tanking with residential real estate down 8% in just the past 2 quarters -- so why the disconnect? We feel the stock market has become disconnected from reality in the REIT space as seniors are looking too closely at dividend yields and not spending enough time evaluating cash flow statements and balance sheets in the sector. In other words, BXP could make a good long term short from here.
(DDS) -- Dillards is a seemingly reasonable stock, but behind the scenes trouble could be brewing. Like Cancer, you have to get rid of trouble early in your portfolio, and the last time the economy went into recession Dillards got into serious trouble, dropping from $30 to $4. At a price of $50, Dillards is more trouble than it's worth in my view. Investors looking to play the short side have history on their side of the tape -- selling the September $50 call options seems like a good way to bet against a company that has historically been very insulated from the actvist value community and from their outside shareholder base.
(CMG) -- Chipotle was recently caught in a class action lawsuit regarding their hiring of illegal immigrants. If Faruqi and Faruqi can dig up some information on CMG, current investors could be left holding a very expensive bag indeed. CMG is trading for 47X earnings and if the lawsuit is correct the company's earnings could have been substantially boosted in the short term from illegal business practices. If the ICE cracks down on the company, the future profitability of the company could face headwinds as paying non-illegals is significantly more expensive than paying undocumented workers from Mexico and Latin America. The shareholder suits, high valuation, as well as slowing same store sales growth seems to give CMG shorts a strong argument for lower prices for the common stock ahead.
(OPEN) -- Opentable.com has crashed significantly from their highs of $110 per share, but the stock is still overvalued with a PE ratio of 128X and a future which is highly speculative relative to the company's current market valuation. Just because a company displays strong growth and is in the internet sector does not make it worth 30, 50, or 100 times earnings. Looking at the stocks of Earthlink and United Online for example we can see that eyeballs and clicks do not always equate to shareholder returns. Open faces competition threats from Google, and from other businesses in the space. Companies may find a way to introduce mobile applications which compete with OPEN in the future as well. In essence, the business has very little in the way of competitive moat while the stock commands a huge premium as far as valuation is concerned. Saturation is also an issue for this name. The 200 day moving average for OPEN is $79.65 and the stock closed on Friday at $79.40 -- I will be watching the 200 day moving average closely although the short thesis here is 100% fundamental in nature.
(SFSF) -- Successfactors looks like a bubble to me at 258X forward earnings. I have been bearish on the name for quite some time, and despite the strong growth in sales and the excitement over cloud computing, SFSF looks like a good short here. I am selling the September $30 calls here for $3 which should provide some margin of safety in case the market remains irrational in the coming months. The stock has a valuation on cash flows that is similar to the overvaluation on earnings. Book value is also negligible as the stock is trading for around 8X book. Price to sales for the company at 11X looks pretty rich as well as the fact that the company has continued to issue stock over the past couple of years. While I like the business, I don't like the valuation at all.
(DRN) -- The Direxion Triple Leveraged REIT fund is the ultimate speculator vehicle, but unfortunately for longs this leveraged investment is betting on REITS in the wrong direction in my view. With real estate falling across the country, betting on REITS seems like a naive and reckless play. The DRN suffers from slippage and leverage costs Holding this investment over time is likely a bad trade, but selling the $80 October calls seems like a wise investment to me. DRN has suffered during the recent downward move for REITS but the sell-off seems to be just getting started. Investors shorting any stock here should keep a sharp eye on the 200 day moving average on the overall markets which is $1257 or so on the S&P 500 and $55.43 on the QQQ.
(GMCR) -- Green Mountain Coffee suffers from the same problems as most of the stocks above: a great company at a terrible price. The business has patent issues looming as well as accusations of accounting problems by Sam Antar. Antar (convicted felon and former CFO of Crazy Eddies fraud scheme) claims that GMCR violated Regulation G and has filed false and materially misleading financial statements. Antar is a colorful ex con, but he clearly understands accounting and I believe his analysis of GMCR is likely spot on -- I am short GMCR for full disclosure. Here is a link to Antar's blog post on GMCR entitled, "Green Mountain Coffee Roasters: Do They Know How to Count the Beans?"
Disclosure: I am short GMCR, CRM, LNKD, OPEN, SFSF, DRN, BXP, CMG, NFLX, DDS.