In this article, I present three companies, which I feel represent solid shorting opportunities. These three organizations have each experienced a very strong run-up in stock price despite the underlying fundamental condition of the organization. I believe that pure speculation is currently driving the stock price of these companies, and individuals would be wise to prepare to short on a resumption of the fundamental downtrend.
General Growth Properties
General Growth Properties (GGP) has had a nice year in which the stock price has risen nearly 40%. This rise in share price represents an increase of nearly $8 billion in market cap. The rise in share price comes after a restructuring agreement in mid-2010 and represents the emotions of investors who believe that the worst has passed.
The 10-year fundamental picture of this organization is displayed in the chart below.
The chart shows return on assets, return on equity, and the market cap of the firm. Return on assets measures the effectiveness of the firm in using its assets to generate profits, while return on equity represents the ability of management to generate revenue on direct shareholder investment. Market cap is the dollar value that the market attaches to the organization, and it is very interesting to note the correlation between firm performance and market cap.
The chart clearly shows a firm that has been in fundamental decline for the past four years. Beginning in late 2007, the firm began experiencing negative returns on assets and equity. This means that for every dollar of assets or equity the firm possessed, it ended up losing on its position. The market responded to these losses by valuing the organization appropriately lower. As can be seen, the return rates of the firm are closely correlated to the market value of the firm. As the returns began suffering in 2007, market cap followed closely, shedding most of the value of the firm. Despite such a bleak fundamental position, many investors seem to believe that the recent restructuring of the organization warrants an increase in share price. I believe that the 40% year-to-date performance represents speculative exuberance and departs from the historic norm for General Growth Properties. This said, I believe a fundamental "short" is more than warranted in light of the run-up in share price.
Technically speaking, the stock is undeniably in a strong uptrend. This trend has propelled the stock to several year highs, but I believe that investors are in the process of re-examining the long-term fundamentals of the company. I believe that shorting GGP now is acceptable with a tight stop-loss at $21.50. For the more cautious investor, I believe that a more conservative shorting entry is around $18 per share, or when the upward trend line is broken.
Prologis Inc (PLD) has rallied over 15% this year. This represents nearly a $3 billion increase in shareholder value over the past seven months despite the fact that the fundamentals of this firm are very weak. The organization regrettably uses $257 million per year on dividends, so speculative investors have been rewarded with a 3% dividend yield on their investment.
In the chart below and annotation, I have described the fundamental condition of Prologis.
The chart shows the return on assets, return on equity, and market cap of PLD. For the past four years, Prologis has suffered to use its assets and direct shareholder investment to generate profits for the firm. This struggle has been evident in the fact that in only five quarters of the past three years the organization has earned a profit.
Despite this situation of consistent loss and firm degradation, shareholders have added $12 billion of market value to the firm in the past two years. I believe that investors who have purchased these shares have done so on the basis of speculation. I feel that these investors have ignored the fact that PLD has struggled to earn a return on its assets for the past 10 years. Additionally, the firm has lost nearly $5 in net income for every $100 of direct shareholder investment on average for the past four years. These losses stand in stark contrast to the current year-to-date share performance of 15%.
Technically speaking, PLD is in a period of consolidation. The price has failed to make new highs after the initial run up this year, which places the stock in a position of weakness. The tactical investor should wait until prices try once again to attack the $36 per share boundary before shorting. More conservative investors should short on a break of the ascending trend line, which would put the entry around $32 per share.
Liberty Global (LBTYA) has increased in share price an astounding 36% this year. This increase in price represents an addition of nearly $5 billion in shareholder value and also represents a decoupling from the long-term fundamentals of the organization.
In the following chart, I have included three elements that embody the fundamental landscape of LBTYA.
The chart contains the return on assets, return on equity, and market cap for Liberty Global. Return on assets measures how efficiently the firm is able to use its assets to generate net income. Return on equity measures the effectiveness of management to utilize shareholder equity to generate profits. Market cap is the value that the market assigns to the firm based upon share price and shares outstanding.
There is a strong relationship between return on assets, return on equity, and market cap. As the firm becomes better operationally, its returns increase and the market assigns a higher value to the organization. As the firm suffers, the returns and market cap both decline. Beginning in late 2006, LBTYA began suffering from a fundamental standpoint. This struggle was embodied in the fact that it lost money for two years straight and share price declined nearly 70%. In 2010, the firm began to earn slight profits, and the market responded disproportionately with a stock rally of nearly 280%. In late 2011, the firm once again began to lose money, however the stock price continued to rally. This difference in fundamental performance of the firm and stock performance represents a perfect shorting opportunity. The firm has continued the same lackluster performance that drove the share price to decrease 70% in previous years, yet the stock price has rallied in this instance. Such a clear divergence between firm value and market value is an excellent shorting opportunity for the nimble investor.
Technically speaking, the stock is currently in an uptrend. Price has established new highs throughout the year, and I believe the market is currently in the process of realizing that it has bought up a security that is currently experiencing decay in fundamental value. Since price seems to be making a pullback, it makes sense that aggressive traders could potentially profit from shorting now. I believe that a stop loss for aggressive traders who immediately short should be $57 per share, since if price reaches this point, the stock will have violated the definition of a pullback by making a new high. Conservative investors should wait until price falls below the ascending trend line prior to initiating a short position. This places the conservative entry at around $50 per share.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.