Hating These Companies Can Be Hazardous to Your Wealth

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Sealy MattressSome bears never hibernate -- we're talking about the worrywarts out there, betting against companies by initiating short positions.

In a nutshell, a short is an investment that appreciates when a stock heads lower. Bears will short a stock by selling shares borrowed from their broker. They then cover their positions by buying them back, ideally at lower prices so they can make some money. Selling first and buying later -- reversing the traditional order -- may be frowned upon by some investors, but it's a perfectly legal practice.

It's also very popular in volatile times.

Short People

Unfortunately for shorts, betting against a company can backfire on them. If the stock ticks higher on good news or general market optimism, those betting against the stock may find themselves scrambling to cover their short positions before they lose even more money. When too many shorts are rushing for the exits, the act of purchasing the stock to close out their positions creates what we call a short squeeze.

Here's where something called the short interest ratio should be every worrywart's friend. The metric divides the number of shares sold short by the trading volume on a typical trading day. The larger the short interest ratio, the more likely that we'll see a short squeeze because of the spike in demand for buy orders.

5 Companies That Would Be Dangerous to Diss

Let's take a look at a few of the stocks with the highest short interest ratios as of the end of last month, making them dangerous to bet against unless a bear is absolutely sure about where the company's stock is heading.

• Sealy (ZZ): Short interest ratio of 75 days (13 million shares short on 172,976 daily volume)

The story: The leading mattress maker has been tossing and turning at night. Sealy stunned the market by posting a sharp loss in its latest quarter when analysts were braced for a small profit. One analyst downgraded the stock on the "distressingly disappointing" showing.

What can go wrong for shorts: Despite the success of rivals making premium form-fitting and air-chambered mattresses, Sealy still has many popular brands in its portfolio. Analysts also see a return to slight profitability this fiscal year.

• MannKind (MNKD): Short interest ratio of 39 days (27.1 million shares short on 692,640 daily volume)

The story: Diabetics were cheering on MannKind as the company was trying to push an inhaled insulin called Afrezza toward regulatory approval. No more insulin needles? Sweet! Well, not so sweet. The Food and Drug Administration failed to clear the treatment, leaving MannKind with mounting losses as it bleeds through its cash.

What can go wrong for shorts: MannKind already shed two-thirds of its value last year, so it's not as if bears are new to this story. There have also been several acquisitions in the pharmaceuticals industry lately, as larger drugmakers snap up promising biotechs. MannKind may seem to be an unlikely buyout candidate, but anything is possible.

• Logitech (LOGI): Short interest ratio of 28 days (12 million shares short on 422,895 shares)

The story: Logitech is a major maker of third-party hardware accessories for computers. If you have an optical mouse or a detachable webcam that didn't come packaged with your original computer, you may very well own a Logitech device. Unfortunately, the success of smartphones and tablets that don't require third-party hardware accessories are eating into Logitech's performance.

What can go wrong for shorts: PC and laptop sales were sluggish last year, but this is far from a dead market. Logitech has also embraced the "good enough" computing trend by rolling out new accessories for tablets and mobile phones.

• Tesla Motors (TSLA): Short interest ratio of 28 days (23.7 million shares short on 851,090 daily volume)

The story: The original Tesla Roadster turned heads, but didn't attract enough buyers, given its lofty sticker price. The plan to roll out more affordable Model S sedans -- starting at $50,000 -- later this year is encouraging, but now that we've seen Chevy Volt batteries catch on fire days after a collision, electric cars have an even steeper uphill climb.

What can go wrong for the shorts: Once the Model S hits the road at a price point that isn't much more than the Volt or other electrics and electric hybrids, its visibility may prove to be contagious. Tesla is nowhere near profitability at the moment, but a growing presence will help see it through, if not smoke out a major car manufacturer as an outright buyer.

• GameStop (GME): Short interest ratio of 24 days (39.8 million shares short on 1.7 million daily volume)

The story: Video game sales have been languishing since 2009, and console makers updating their systems may not attract casual gamers who are killing time elsewhere. Every passing quarter over the past year has seen the small-box video game retailer hosing down its guidance for store-level sales. Digital delivery is another threat, rendering physical distributors obsolete.

What can go wrong for the shorts: GameStop has held up better than the industry itself. Strong customer loyalty and a wildly successful program where gamers trade in used games and gear for store credit have kept GameStop's profitability growing at a time when the niche is going the wrong way. The long-term outlook is gloomy for GameStop, but the stock appears cheap in the near term.

Longtime Motley Fool contributor Rick Munarriz does not own shares in any of the stocks in this article. The Motley Fool owns shares of Logitech International and GameStop. Motley Fool newsletter services have recommended buying shares of Tesla Motors and Logitech International, as well as writing covered calls in GameStop.




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rfkramden

Short the GOP in 2012. Maybe this will be the end of the line for the selfish, spoiled rich brats that destroyed the American Economy. One can only hope.

January 25 2012 at 2:25 AM Report abuse +1 rate up rate down Reply