9 Short Sale Candidates for Hedging Market Risk

by: Hedgephone

To buy the dip or not to buy the dip, that is the question investors will be asking themselves over the next few days. Clearly, greed has trumped fear for the past six months, but the rising wedge pattern in the Nasdaq has been broken to the downside and the Nasdaq failed to break out above the 2007 highs at $2,800.

What the overall valuations in the market and the technical levels are telling me is that now is a good time to be fully hedged against market (systematic) risk -- meaning I will be long undervalued stock and short overvalued stock in similar amounts. I also think oil is headed much, much higher.

Here are 9 investments that I feel are overvalued and investors looking to add exposure to on the short side this week may want to consider the following stocks for short selling or put buying:

  1. OPEN: Open Table is a growing business that is sort of cloud based, but the company's market is not infinitely large which is what its 150 PE ratio would suggest. OPEN has been correcting with the market and I would look to cover my shorts in the mid $60 range. I am short the stock, short put options as a hedge, and short some bear call spreads (short the $110 calls and long the $120 calls that expire in Jan. 2012)
  2. CMG: Chipotle was said to "beat and raise" on earnings and because of the strong chart I actually went long stock before earnings as a hedge against my short call option position and sold the day after earnings. I am very glad I did, as the stock shot up to $275 or so before retreating to $245 per share at Wednesday's close. I am short the June $260, $270 and $290 call options as guidance for same store sales growth in the low single digits does not warrant a 40 plus PE ratio. I do think the shares could trade higher but that mainly it's a market direction issue more than a company specific one which is why I would rather sell longer dated calls then directly short the name.
  3. LULU: Lululemon's trendy yoga gear has achieved phenomenal growth, however at $78 per share the growth rate of the past quarter will need to be maintained to warrant the high PE and P/B ratios that LULU commands. Be very careful here as LULU is a favorite of IBD (who I highly respect) and of the HFT squeeze machines.
  4. CRM: Salesforce.com reports earnings on Thursday, so I will be looking to buy some front month call options to hedge my short position or will cover half of my position before earnings due to my past experience with holding short positions in momentum stocks into earnings. I do feel CRM is one of the most overvalued stocks in the market -- however, the growth rate is real and the company is a cutting edge leader in cloud computing. At over 200 times earnings, the company is just too overvalued to ignore and I am short the April $150 call options in the name.
  5. SIGA: SIGA rallied nearly 20% Tuesday on the news the company will get a government contract. With a 200% run over the past year and no earnings or balance sheet assets to speak of, investors are placing too much faith in Uncle Sam to boost this company's profitability in my view. Price to book value is off the charts as SIGA has $6MM in the bank with a market cap of over $600MM -- this means that their IP is either world shaking or the company is woefully overvalued. SIGA has no PE because the company is not profitable.
  6. BSQR: B Square Corporation is in the hot mobile applications space, yet the company doesn't have a track record of profitability. Although a more speculative short, BSQR makes huge moves which can be faded by well timed short selling. BSQR trades at over 6X book value but I view this as a trade and not a long term short sale.
  7. IWM: The Russell 2000 is a collection of overvalued names at this point and is likely doomed to a 2008 flashback eventually. Investors who own this in their accounts should sell it and buy the S&P 500 instead if they are long term index fund investors. Higher oil prices tend to hurt small business the most, so long investors should be very careful in the Russell trading at 3.5X book and 30 times earnings.
  8. MDY: Same goes for the Mid Cap index which is incredibly overvalued as well with many sites listing the index fund's valuation at 93 times trailing twelve months net profits.
  9. SFSF: Successfactors is my favorite short position right now as the company has not made a profit in years, yet the stock commands a huge price to sales and price to forward earnings ratio. SFSF is more of a long term short as the shares appear to be supported by "sky hooks" and a sympathetic market maker. That said, SFSF is a leading cloud computing offering and the growth in sales and cash flows are notably strong.

The problems in the Middle East and the psychologically significant $100 level in oil prices make the overall equity markets risky here when combined with lofty valuations and a general trend toward complacency among market participants. Now may be a great time to short this market, but for my money I will be fully hedged with a small barbell type put option exposure and call options on the Rogers Raw Materials Index, the GLD, and a long position in Silver.

Disclosure: I am short CMG, LULU, CRM, IWM, SFSF, OPEN.