A popular hedge-fund strategy to hedge against market declines is known as long/short equity. The strategy was popularized in the 1940s by Alfred Winslow Jones, an Australian-American writer and one-time diplomat. There wasn't much competition back then, so Jones took advantage of mispriced stocks and completely crushed the market. This strategy still exists today and it still works. Today markets are generally more efficient and there's increased competition. Long/short equity is not quite as easy as it was decades ago, but it's still effective!
The main idea is that you want to own stocks in quality companies with reasonable valuations while avoiding and/or betting against unprofitable and overvalued ones. When companies have more liabilities than assets and are losing money, then how will they stay in business? The answer is that they likely won't. Equity investors are notoriously optimistic about turnaround prospects, creating opportunities on the short side. There are risks, such as the famous 2021 short squeezes in GameStop (GME) and AMC (AMC), but investors can use options to eliminate the possibility of a short squeeze costing more than their initial investment. Without further ado, here are the stocks to sell (if you own them) or short.
Carvana is a cash-burning machine that had a huge run-up during the pandemic. The financial statements tell a wild story of a company issuing tons of shares only to turn around and lose the money in the business. There's a lot I could say about Carvana, but this really isn't that complicated. The company has about $9.6 billion in assets and $9.2 billion in liabilities, nearing negative net worth. Negative net worth is a classic accounting red flag and it generally means exactly what you think it means. There are some exceptions, for example, some real estate and oil, gas, and mineral assets companies will take large amounts of accounting depreciation, but Carvana is not an exception to the rule.
They lost about $870 million over the past 12 months, and analysts expect them to lose another $700 million or so in 2023. This stock was never anything more than hype and promises. They're selling off assets now to stay afloat, and have hired bankers to look into restructuring (i.e. bankruptcy).
The stock is up a bunch this year as part of a broader meme stock renaissance, but if investors start pumping up the stock and the company does a secondary offering, it will simply fund their losses and buy them a little time, maybe only a matter of months. The main difference between 2021 and now is that then, the Fed was pumping trillions of dollars of liquidity into the system, and the Treasury was handing out stimulus money, giving meme traders tons of ammo to send stocks flying. Now, the Fed is pulling liquidity out of the system and the stimulus money is spent and gone, so there's no ability for traders to stage a repeat of what happened in 2021.
You can pick up CVNA $5 January 2024 puts for about $2.50. I view the odds of CVNA being above $2.50 in a year as pretty low, and recent reporting of creditors forming a pact indicates to me that the odds of CVNA being a penny stock or delisted in bankruptcy may be fairly high. Realistically you could cover when it goes below $1 and move on.
Beyond Meat is another stock that was a market darling in the early days of the pandemic, but has since lost its luster.
This isn't super complicated either. BYND has $1.14 billion in assets and $1.28 billion in liabilities. They're underwater by about $142 million, and analysts expect them to lose another $240 million or so in 2023. They have a lot of debt, there are plenty of other companies that can sell veggie meat, and the company is eventually going to run out of money.
$10 January 2024 puts for BYND are heavily owned, and you can pick them up for around $3.75. BYND could go to zero in the next year, but it also could trade to $2-3. In the latter case, you would double your money. The jury is in on the product as well, and most people who eat meat want to eat normal meat, whereas most vegetarians aren't thrilled with the idea of something that tastes like a bloody hamburger, but is actually vegan.
Wayfair is another crazy stock that had a huge valuation during COVID and now is forced to face the reality of losing money. They sell furniture on the Internet. The stock has soared this year off of a strange upgrade by JPMorgan and a short squeeze. However, the true value of the shares are closer to zero.
Wayfair has $3.6 billion in assets and $6 billion in liabilities. That's a nightmare number for a furniture company. Analysts expect another $400 million in losses for 2023. This is nothing new, the only year in the last 10 years that the company made money was during the lockdowns in 2020.
For W stock going to zero, you can get 5-1 on the $45 Jan 2024 puts (trading for about $9.70), or 8-1 on the $25 puts (trading for about $2.90). It's honestly hard for me to see Wayfair trading above $10 given how harshly consumer demand has shifted away from goods. The accounting signs are textbook from the quarterly balance sheets – rapidly-rising inventory, a current ratio about to flip negative, and a growing retained earnings deficit.
Carnival Cruise is another meme favorite that's in over its head with debt on speculative turnaround plans. Carnival technically has more assets than liabilities (when you count the "value" of their cruise ships and goodwill), but the current ratio is where their problems are, with $7.5 billion in current assets and $10.6 billion in current liabilities. A negative current ratio is another classic accounting red flag to be aware of.
Analysts expect them to roughly break even this year and return to profitability after, but I think this is too optimistic. Consumer spending at large is unsustainable, and cruises are among the most discretionary purchases consumers can make. It's not clear where Carnival is going to get the money to pay its $3 billion current liability hole, because it's about a third of its market cap, another secondary offering could put a lot of pressure on the stock.
The options for CCL are fairly cheap, Jan 2024 $7.50 puts are about $0.90, while $10 puts are $1.75. All it takes is a recession, another COVID wave, or even poor execution at the company, and CCL could trade to $2 or lower. CCL's massive debt load, accumulated losses, and hypervulnerability to the macroeconomy make this a brutal stock to try to be long.
If you haven't caught on by now, consumer discretionary stocks with weak balance sheets are among the worst companies to invest in. There are a lot of reasons for this, but most of them relate to the bias of investors to invest in what they know, propping up valuations for money-losing consumer-facing companies like airlines, automakers, and cruise lines.
Along the same lines, betting against stocks like American Airlines (AAL) makes an excellent hedge for your portfolio because events that are simply bad for the global economy (war, oil shocks, terror, pandemics) are devastating for airlines. If the global economy sneezes, airlines will get the flu. While AAL is underwater in terms of liabilities, the stock escaped my problem-child list because it's expected to earn a nice profit in 2023. However, anyone who has invested in airlines knows how quickly things can change.
Betting against the largest market cap stocks in the market is another research-backed strategy to reduce concentration and get away from overvaluation. Apple (AAPL), Amazon (AMZN), and Tesla (TSLA) are the most popular targets for investors looking to reduce index concentration and avoid overvaluation.
Companies like AMC are obvious shorts, but the metagame here is to figure out some of the less obvious shorts because the payoffs of the options are much better. For what it's worth, GameStop can bumble along for years with the cash it has, making it a poor target for short selling.
Here are the one-year put option payoffs from these recommended trades.
W- 5-1 (8-1 if more aggressive)
CCL- 5-1 (8-1 if more aggressive)
If I had to guess, purely from looking at their financials and scanning news coverage – two of these companies will file for bankruptcy sometime in 2023 or early 2024, and if unemployment rises significantly, all of them will. Zombie companies that refinanced debt over and over and covered their losses on top of it are simply going to run out of money in 2023 and 2024.
In the style of Alfred Winslow Jones, I've selected companies that are likely to severely underperform the market and that make good targets for short bets. Conservative investors who hold these stocks should sell them, while risk-taking investors should consider shorting them with options. Do you have a company that you think belongs on this list? Share your thoughts below in the comments!
This article was written by
Disclosure: I/we have a beneficial short position in the shares of W, CCL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.