A good short signal occurs when forward multiples approach the century mark, bullish sentiment is extreme, and company insiders are aggressive sellers of their stock. Throw in a "price to book ratio" in excess of 10, and you have the perfect recipe for a mouthwatering shorting opportunity. The following three momentum stocks all share the same characteristics and should be considered as prime short candidates.
LinkedIn (LNKD): This company is really just a job board when you really get down to it. How high could its moat be when Google (GOOG) or Facebook (FB) could easily replicate its model? The company's market cap in excess of $13 billion, gives the impression that Wall Street thinks it could be on the verge of discovering a cure for cancer, or a pill that stops the aging process.
Is this bubble being maintained by a conspiracy on Wall Street to allow the smart money to exit their positions at the expense of the retail investor? The "pump and dump" mentally of the analyst community is more than evident. Believe or not, the shares are selling at 95 times 2013 earnings estimates of $1.30, implying that its earnings will more than double its 2012 earnings estimates of 62 cents- a pretty tall order in my book.
Insiders are selling like there is no tomorrow and have dumped 5.9 million shares in the last six months alone, representing a staggering 6% of LNKD's total outstanding shares. If you think that's bad, insiders have sold approximately 98% of their holdings according to yahoo finance. The balance sheet does not support the stock price either, as the company holds a paltry $600 million in cash (amounting to just 4.6% of its market cap) and sells for an astronomical 16 times book value.
Amazon (AMZN): There is no doubt Mr. Bezos continues to pull a rabbit out of the hat, enabling him to confuse, manipulate and amaze a very naive and gullible cross section of investors. If things are as good as everyone proclaims, then why are AMZN insiders running for the exits at a feverish pace? These guys have dumped $50 million worth of shares in the past six months alone.
Earnings are forecasted to triple in 2013 to $2.39, from a forecasted 77 cents in 2012-that seems like a lofty goal considering AMZN is losing its sales tax advantage, while piling on fixed costs related to its aggressive warehouse building program. Does AMZN really deserve to sell for a forward multiple of 109? Just like LNKD's balance sheet, the company underwhelms at 16 times book and a cash pile representing only 5% of its market cap.
Salesforce.com (CRM): The shares are selling at a nose bleed 107 times non GAAP 2013 earnings estimates of $1.50 and 80 times its fiscal 2014 estimates of $1.99. The GAAP versus non GAAP debate has been argued ad nauseum, so I am not going to dwell on that topic, other than emphasize, it is a big reason relating to the perception of CRM's success. The reality is, under non gaap accounting, your expenses shrink when employees are paid in stock, rather than salary. This gives the illusion of a better bottom line, and is one of the reasons why insiders sold 369,000 shares in the last six months.
Earnings growth of 33% won't be easy in 2014, when considering mammoths such as IBM, SAP, Microsoft (MSFT) and Oracle (ORCL) will be fighting for a bigger piece of pie in the cloud arena. The company is selling at eight times book value (it has about $1 billion of goodwill on its books). Its cash position relative to its market cap is also near the 5% level.
Going against the grain: I realize it is unadvisable to be short in momentum stocks, especially when they are trading in new high territory, but with the increase risk of doing so, the reward also rises exponentially. When a Einhorn moment arises or a bad report, these type of stocks are too difficult to short as they can implode in a matter of minutes, or worst yet, a potential short seller will not be able to find any shares to borrow. I definitely want to be short, when "you know what" finally hits the fan!
Could these darlings of Wall Street become the next OPEN or NFLX? Many think so, but as we all know, the market can stay irrational longer than anyone disagreeing can stay solvent. In the meantime, these companies are being pumped up with sky-high expectations, as new speculators count on the premise that they will be able to find greater fools down the road to unload upon. The higher these companies rise, the farther their eventual fall back to earth will be. The reality is, stocks tend to drop twice as far and at twice the rate on bad news, as they rise on good news. This would have to be the case, as short selling is a much riskier proposition (you are exposed to unlimited losses) than going long, hence the higher reward potential.
The truth is, fear is a much more powerful emotion than elation, when it comes to the stock market. Why is it that most stock market participants have an extremely short memory? They fail to recall events like the tulip craze, the dotcom bust and the 50% drubbing the market took between October 2007 and March of 2009. One thing for sure, history always tends to repeat itself.