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With markets once again nearing their highs it is always wise to hedge your bets. A smart investor during uncertainty will take one short position for every long position. If done correctly, this can yield a profit whether the markets fly up, crash, or remain stagnant. The trick is to choose a stock with great potential upside for the long position and to choose a stock in bad financial shape for the short. Here I will lay out my current strategy with two stocks.

The first stock I'd like to talk about is Casella Waste Systems, Inc (CWST):

(click to enlarge)Yearly Chart of CWST

CWST makes an excellent short candidate for many reasons:

  1. It is currently in a downward trend.
  2. It has made a consistent net loss for the last four quarters and shows no signs of changing that soon.
  3. It has a "current ratio" of less than one, meaning current liabilities are larger than current assets.
  4. The company has needed to borrow money three out of the last four quarters.
  5. For fiscal 2012, operating income has been lower than their interest expense alone.
  6. Assets have been decreasing over the years instead of growing.
  7. Insiders have been selling recently.

Information from Yahoo Finance.

The next stock I'll bring up is Xinyuan Real Estate Co., Ltd. (XIN):

(click to enlarge)Yearly Chart XIN

XIN makes an excellent long candidate for many reasons:

  1. It is extremely profitable, currently with a Price Earnings ratio under 2.
  2. Cash flow is very solid. Cash flow from operations can cover all costs.
  3. It pays 16 cents a year in dividends. (6%) This is done with four quarterly dividends of 4 cents each. (Up from 10 cents the previous year)
  4. It recently announced a 20 million dollar buyback of its shares.
  5. Assets are increasing and liabilities decreasing year over year.
  6. It went through an IPO and currently has a big four auditor giving it a much cleaner slate than many Chinese companies.
  7. Shares have minimal downside risk as the dividend yield grows higher as the stock lowers.

Information from Yahoo Finance.

Conclusion:

The market is an unpredictable beast. Limit your losses by hedging. Always choose one short position for every long position and you will have a much easier time sleeping at night. I know I do.

Source: 1 Stock To Short And 1 To Buy