5 Potential Shorts If We Go Higher

Includes: AMZN, GOOG, KCG, NFLX, S
by: Bill Maurer

Over the past 10 days, U.S. markets continued an extended rally, even though the Federal Reserve slightly disappointed when it came to QE3. The markets are still hoping for more Fed action, and the potential for Europe to actually get its house in order. The July jobs report was actually strong, although many have questioned impacts of seasonality. We'll see what happens when the August report comes out. But anyway you slice it, markets seem a bit overheated, and many do not trust this rally. For those looking for a pullback, there are some decent potential short opportunities out there. Here are five that I've found that investors might want to look at.


For a standard stock, if you were to pay a "reasonable valuation," what would that be? Maybe 10, 15, even 20 times earnings? Depending on the company and its potential growth, you may even be willing to pay 30 or 40 times earnings. But for this argument, let's use 20 times. At a price-to-earnings ratio of 20, you are paying 20 cents for each penny of the company's earnings.

So would it seem reasonable to pay nearly $4 for every penny of a company's earnings? Probably not, and yes, I said four dollars. Well, when it comes to Amazon, the valuation is getting there. If Amazon loses the 8 cents per share this quarter that analysts see it losing, the trailing twelve month earnings will be just $0.59. Based on Friday's close of $232.75, that would put the trailing P/E at 394.49 times. You are paying nearly 400 times earnings for Amazon. To me, that valuation is just ridiculous, and it will contract.


When I covered Netflix's latest quarter, I said that shares would continue to go lower after another so-so report. But I've also mentioned numerous times that when it comes to Netflix, we see the stock hit a new low, then we see a huge move back up, before another drop occurs. Well, we are getting to that point again.

Netflix hit a 52-week low recently at $52.81, and at Friday's high, was up almost $8 from that point. In fact, Netflix was up more than 3% on Friday, up even more at times, after Netflix CEO Reed Hastings bought $1 million in stock. But here's the funny part. It wasn't Netflix stock. Hastings bought $1 million in Facebook (NASDAQ:FB) shares, and he is a member of that company's board. But it makes one wonder, if a company's CEO is buying shares of another company, and not his own, what does that mean for Netflix? If Netflix shares rise a few more dollars, they will have bounced 25-30% or more off the recent low. That provides your opportunity to short this name again.


I stated that after the latest quarter, Google remains quite unimpressive. Google has underperformed the overall technology sector over the past couple of years, and as I've noted in several articles, the upper end of its trading range is $650, just above where we are now.

Google saw Q2 gross margins drop 120 basis points over the prior-year period, and that doesn't include the Motorola acquisition. When included, gross margins dropped 6 full percentage points. Google just launched the Nexus tablet, which will also hurt margins. Apple's (NASDAQ:AAPL) gross margins on the iPad have been 23 to 32%, so figure the Nexus won't have sky-high margins. Google's gross margins in Q2 were about 59%, so expect the Nexus to pressure margins even more. This space is becoming more competitive by the day, and Baidu (NASDAQ:BIDU) is killing Google in China. Google is strong in the U.S., but others are catching up. This is not the technology leader it was several years ago.

Sprint (NYSE:S)

I've been a bear when it comes to Sprint because of its immense losses and huge debt pile. Shares have rallied hard from the low $2s just a few months ago, now challenging the $5 level for the first time in about 13 months.

But today, I'm taking a different angle on Sprint. I'm not saying to short it for an extended period of time. In fact, it's quite the opposite. Sprint has become the ultimate trading stock, and on the next rally, which will probably be to the $5.25 to $5.50 level, I encourage investors to look at this potential short.

Since the beginning of May, Sprint has made eight separate moves to the downside of more than 20 cents. That doesn't seem like much, but percentage wise it is when you are talking about a $3 to $5 stock. These moves have been quick, usually only taking a couple of days. The following table shows Sprint's quick drops.

Dates High Low Change
5/15 to 5/18 $2.54 $2.32 $0.22
5/29 to 6/4 $2.67 $2.44 $0.23
6/11 to 6/12 $3.08 $2.80 $0.28
6/25 (intra-day) $3.28 $3.05 $0.23
7/5 to 7/10 $3.48 $3.15 $0.33
7/19 to 7/25 $3.73 $3.31 $0.42
7/31 to 8/2 $4.60 $4.00 $0.60
8/9 to 8/10 $4.96 $4.71 $0.25

Anytime you can pick up 25 or 30 cents on a $5 name in just a few days, you have to take that opportunity. Investors who want to be long can be, but by shorting Sprint even for just two or three of those down moves, you could have made an extra 70 cents or more. Percentage wise, that's quite a return on this name.

Knight Capital Group (NYSE:KCG)

By now, everyone has probably heard what happened with this name. A software error caused a trading glitch, causing the company to lose $440 million dollars. Many customers fled initially, and it wasn't until a last ditch effort to obtain financing that Knight was saved.

But ultimately, that financing was very costly. Preferred shares, carrying a 2% interest rate, can be converted into common shares at $1.50, about half of Friday's $2.90 close. In addition, the preferreds would count for more than 70% of all outstanding shares if converted. Shareholders will be diluted heavily, and until then, the company will be paying plenty of interest.

It's just not the equity overhang that makes shares a potential short, it's also the hit to the firm's reputation, which will impact future revenue and earnings per share. Ninety days ago, analysts were expecting a profit of $1.41 per share for Knight. Just 30 days ago, a profit of $1.18 was still expected. But now that number has fallen to a loss of $0.57, and revenue is expected to plunge 36% this year.

For 2013, things aren't expected to be much better. Analysts are expecting a rebound in both revenue and earnings, but still well below 2011 levels. Over the last 30 days, analyst estimates for a 2013 profit have dropped from $1.63 to just $0.36, compared with the $1.42 profit we saw in 2011.

Knight could eventually rebound, but there are too many dark clouds overhead at this point. While the loss was determined at $440 million, it remains to be seen how much revenue and earnings are actually impacted. It could be much worse. Add in the massive dilution that shareholders are facing, and this stock could go much lower from here.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in S over the next 72 hours.