11 Short And Put Candidates

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 |  Includes: APKT, BXP, CCI, CRM, GMCR, LULU, MAKO, MDVN, MELI, OPEN, VRTX
by: Value Research

Investors who seek to hedge their exposure by shorting stocks or buying puts do not have many resources to guide their efforts. There are fewer criteria for constructing a short portfolio as there are for creating a long portfolio. Short sellers who use fundamental analysis tend to advocate one of three fundamental reasons for betting against a stock:

Excessive valuations. This is the result of overzealous or overly hopeful investors bidding up the price of a stock beyond conceivable net present values. Excessive valuations might have nothing to do with the firm itself, and can be the result of investor manias. Excessive valuations can be identified for using price to sales, price to earnings, price to free cash flow, and price to book screens.

Internal problems are caused by poor decisions in a firm’s accounting or operations. Accounting problems range from aggressive accounting to outright fraud. Problems in operations include channel stuffing, rushing products to market, inability to shut down projects that are chronic losers, or are addicted to overpriced acquisitions. A screen for insider selling is a potential sign of insiders losing faith in a company in the face of internal problems.

Fragility characterizes companies that cannot withstand future shocks could be recently hurt from past shocks. Sources of fragility include high debt to equity levels, large and rapidly approaching debt maturities, contingent claims, unhedged commodity exposures, or other unmitigated risks.

As a launching point, valuations were used to screen put and short selling candidates. The intial results of this screen were then filtered for stocks with put markets whose maturities date out to January of 2013. Altman Z-scores were calculated for the resulting list of stocks:

Ticker

Company

Insider Transactions

P/E

P/S

P/B

P/FCF

Last Financial Statement

Altman-Zscore

APKT

Acme Packet, Inc.

-11.0%

61.4

10.9

7.7

81.0

30-Jun-11

34.36

BXP

Boston Properties Inc.

-6.0%

100.3

9.1

3.1

N/A

30-Jun-11

1.38

CCI

Crown Castle International Corp.

-72.7%

N/A

6.1

4.5

33.1

30-Jun-11

0.91

CRM

Salesforce.com

-10.3%

618.1

8.6

11.7

305.7

30-Apr-11

7.11

GMCR

Green Mountain Coffee Roasters

-4.2%

101.5

6.9

8.7

N/A

25-Jun-11

10.67

LULU

Lululemon Athletica Inc.

-10.9%

56.5

10.0

14.8

124.1

1-May-11

51.25

MAKO

MAKO Surgical Corp.

-69.9%

N/A

26.2

13.9

N/A

30-Jun-11

58.08

MDVN

Medivation, Inc.

-93.2%

N/A

9.2

202.3

N/A

30-Jun-11

0.62

MELI

Mercadolibre, Inc.

-10.9%

47.1

12.0

15.2

57.0

30-Jun-11

20.83

OPEN

OpenTable, Inc.

-94.1%

71.9

11.1

10.8

37.0

30-Jun-11

16.49

VRTX

Vertex Pharmaceuticals Inc.

-6.3%

N/A

33.5

30.1

N/A

30-Jun-11

-0.02

Click to enlarge

The results show that there are four firms with high valuations and low (less than 1.81) Altman Z-Scores. Though this measure does not indicate present financial distress, it does raise an alarm about financial weakness that might be a problem in the coming year.

However, some of these stocks could be viable short positions on the basis of valuation alone. If stock prices drop to make these valuations reasonable, current investors will suffer fantastic losses. For example, if OPEN traded at a price to earnings ratio of 16 with current earnings, it would lose 78% of its market capitalization: the price per share would have to drop 78%. If it’s price to free cash flow ratio was to drop to 16, its price would have to fall 57%. There are other alternatives: high valuations will persist, or earnings and free cash flow will grow to make these valuations drop.

Comparing required cash flow and earnings growth required for this to happen with historical growth and analyst estimates for growth will be the subject of a future article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.