5 High-Flying Stocks Short Sellers Are Targeting

Includes: DWA, GME, MNK, RDN, RRD
by: Insider Monkey

By Matt Doiron

Often, momentum carries a rising stock above levels where it is fairly valued, leading short sellers to step in as they speculate that the stock price could decline. This is a risky move - it is, you might say, "catching a flying knife." Of course, stocks with high short interest can sometimes attract speculators trying to rally a stock and thus generate margin calls to drive it even higher. In either case, looking for stocks that short sellers love and that have recently seen strong performance can potentially help identify interesting short-term moves. Using data from Fidelity, here are five stocks that have risen at least 50% year to date and that have at least 20% of their outstanding shares held short as of the most recent data:

One of the most extreme cases of this phenomenon is Gamestop (NYSE:GME). Its stock price is up 63% year to date, and has more than doubled from its levels a year ago. There is an argument that it's actually about fairly valued: at these prices, the dividend yield is 2.7% and the forward P/E is 11. However, over 30% of the outstanding shares are held short on concerns that the PC and video game industry is changing to allow less room for brick-and-mortar stores and sales of used games. We track quarterly 13F filings from hundreds of hedge funds and other notable investors as part of our work developing investment strategies (we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year). According to our database, value investor Joel Greenblatt had Gamestop as one of his top stock picks as of the end of March (find Greenblatt's favorite stocks).

R.R. Donnelley (NASDAQ:RRD), a $2.6 billion market cap company providing packaging products, catalogs, and marketing services, has risen more or less steadily over the course of 2013 to a 58% gain. The company has paid a 26-cent quarterly dividend for the last 10 years, and at current prices that makes R.R. Donnelley a high-yield stock with an annual yield of 8%. However, its margins have been falling and as a result earnings declined by 28% in its last quarterly report compared to the first quarter of 2012. The short thesis is likely that the shrinking business will pressure the company to cut dividends.

Another stock meeting our criteria is DreamWorks Animation (NASDAQ:DWA), which is up over 50% so far this year. The company is unprofitable on a trailing basis and the forward earnings multiple is quite high at 26, though, earnings would be expected to fluctuate strongly from year to year on the basis of how successful DreamWorks's releases are. Its most recent feature release, "The Croods," was reportedly a box office success but we'll have to see how that translates into earnings for the company. DreamWorks recently agreed to produce several new original "television series" exclusively for Netflix.

Short sellers are also excited about mortgage and financial guaranty insurance company Radian Group (NYSE:RDN), with the most recent data showing that shorts are responsible for 26% of the total shares outstanding. The stock price has more than tripled in the last year, including a 90% rise year to date. Recent quarters have generally shown steep losses- and higher losses than analysts expected- though the sell-side remains somewhat optimistic as the forward earnings multiple is 11. Billionaire John Paulson's Paulson & Co. was buying Radian in the first quarter of 2013 (check out Paulson's stock picks).

Questcor Pharmaceuticals (QCOR) is another stock which is up considerably since the beginning of January (though it is actually down from its levels a year ago due to a plunge in the stock price last September) and which has high short interest. Its primary product is best known as a treatment for multiple sclerosis. Analysts expect considerable future earnings growth: the trailing and forward P/Es are 14 and 10, respectively, with a five-year PEG ratio of 0.4. This places it in conflict with the views of Questcor bears.

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

Business relationship disclosure: This article is written by Insider Monkey's writer, Matt Doiron, and edited by Meena Krishnamsetty. They don't have any business relationships with any of the companies mentioned in this article and they didn't receive compensation (other than from Insider Monkey and Seeking Alpha) to write this article.