After breaking down the 20 most widely held U.S. stocks, it seems only appropriate to consider the 20 most shorted. This should be interesting; after all, we'll be comparing apples to oranges, black to white, yin to yang. Except, not really. A full 30% of the most frequently shorted stocks are also among the most widely held. We have a battle royale goin' on.
Selling stocks short
First, you should know that shorting a stock is not unlike borrowing your sister's shoes, selling them to the neighbors, and then hoping to find a pair just like them later at a lower price. If things work out, you simply return the shoes to your sister and pocket the difference. That's what short sellers do: They sell borrowed shares, put the proceeds in their account, then buy the stock back and return it. If they buy it back at a lower price, they make money.
It's when a stock rises -- and keeps rising -- that short sellers start to scream. After all, they'll need to buy the shares back eventually and can easily end up paying a much higher price than they sold them for in the first place. Imagine you sold short 1,000 shares of Cisco Systems (NASDAQ:CSCO) at $13. It's now at $18. You took in $13,000 for your sale, but you now need to pay $18,000 to buy back the shares. Not good. That's what we call a "loss."
Shorting is high-risk because such a loss is essentially unlimited. As we've seen, a stock can soar to the sky, at least for a period. During that time, short sellers can be forced (by a broker) to repurchase shorted shares. This type of short squeeze can occur when the original owners want to sell, but their shares have already been borrowed and sold by short sellers; as a result, the short sellers must buy them back so that the original owners can sell. Got that? It's easy. I should be on Oprah to take this stuff to the mainstream.
A short squeeze can also occur as a stock rises and margin calls force short sellers to buy shares back, resulting in an upward cascade of buying pressure. This is prone to occur with widely shorted stocks and those that have a large portion of available shares already sold short. Netflix (NASDAQ:NFLX) and American Pharmaceutical Partners (NASDAQ:APPX) come to mind as two smaller issues with most available shares already sold short.
And this brings us back to our 10 most popular shorts. Because they are so big, these giants don't have a majority of their available shares sold short, but they do have enormous short volume -- the highest of any. So, here, look at the top 10 short positions on the Nasdaq and AMEX based on outstanding short volume as of July, and see what we, as a country of investors, are collectively betting against.
Highest Volume of Shares Short
Issue YTD Stock Return
Nasdaq 100 Trust (AMEX:QQQ) +33%Cisco Systems (NASDAQ:CSCO) +42%Microsoft (NASDAQ:MSFT) +3%S&P 500 (AMEX:SPY) +14%Intel (NASDAQ:INTC) +70%Sirius Satellite (NASDAQ:SIRI) +146%Nextel Commun. (NASDAQ:NXTL) +63%InterActive Corp (NASDAQ:IACI) +64%Level3 Commun. (NASDAQ:LVLT) -4%Juniper Networks (NASDAQ:JNPR) +116%-In order from highest short volume of all to lesser short volume.
-Dividends not included in returns.
-Source: ViWes Investor Info (www.viwes.com)
Shorts losing on poor judgment
Wowsa. The 10 most shorted have risen in price much more this year, as a whole, than the 10 most widely owned. That's something (ouch).
You might be thinking, "Well, this is only for July, maybe these issues are new to the list, and were shorted after rising." In fact, a majority of these issues were among the top 10 all the way back in January. Translation: A lot of people are losing a lot of money betting against the Nasdaq 100, S&P 500, Intel, Cisco, Nextel, Juniper, and these others.
We should remember, however, that a lot of this relates to hedging by giant money managers who are also long the stocks -- those guys and gals who are so confident that every move they make is hedged by a counter-move, all but guaranteeing market-lagging returns. Still, as a hedge, shorting has its place (just as long as individual investors aren't too involved, because who wants to lose to the S&P 500?).
That qualifier aside, there is a good bit of outright, unprotected shorting in these stocks, and that's where we'll take serious issue. Shorting an index -- the S&P or Nasdaq -- is among the lamer things you can do as an investor, especially after two-plus years of a record bear market. People argue that the market still looks expensive, but they're looking in the rearview mirror, while the market has an uncanny way of moving toward the future -- before it arrives.
This year's rising market is telling us that the economy is going to improve in the next, say, 12 months or so. I'm not making a prediction -- that's simply what the market is suggesting. Now, if the economy does improve, and earnings with it, we're going to see rapid contraction in the market's price-to-earnings multiple, such that today's 26 P/E on the S&P 500 could quickly shrink to the teens. (In any upturn, earnings might grow at a strong pace given the poor results of last year from which to grow.)
But even outside the potential for a rebound, betting against the S&P, Nasdaq -- or Intel, Microsoft, or Cisco, for that matter -- as of January 2003, after all were pummeled, well, why do it? Momentum does not work all the way down any more than it works all the way up. Meanwhile, that many short sellers are fighting this recent upward momentum is evidenced by the fact that shorting volume has risen on these leading stocks -- and the market indexes -- all year, even as prices have risen.
If you want to fight the giants, good luck. But realize that shorting a market index is little more than market timing, and nobody can do that well. Meanwhile, shorting the cash-rich technology leaders of our age after they've already tumbled -- hey, there are much better shorts out there. Sirius Satellite was one of them (falling 90% from 2001 to 2003), so it's good to see that one on the list.
As a rule, the Fool has historically suggested shorting (if you're going to short at all; you can easily succeed without ever shorting) companies that are buried in debt, have shrinking business prospects, and are destroying value every year, rather than creating it. We shortedTrump Hotels & Casinos (NYSE:DJT) to good effect on those measures, but let's see how the Big List stacks up.
Issue P/FCF Cash LT Debt
Nasdaq 100 Trust N/A $N/A $N/ACisco Systems 26 8.4B 0.0Microsoft 15 49.0B 0.0S&P 500 24 N/A N/AIntel 24 12.5B 929MSirius Satellite N/A 289M 58MNextel Commun. 135 2.4B 11.6BInterActive Corp 41 5.0B 3.5BLevel3 Commun. N/A 1.0B 6.1BJuniper Networks 315 830M 1.2B-Free Cash Flow estimated on trailing 12 months, to 3/30 or 6/30.
-Cash and equivalents and long-term debt also as of 3/30 or 6/30.
-Price/Free Cash Flow multiple estimated on Enterprise Value.
Only Nextel and Level3 are saddled with debt (in fact, most balance sheets here outshine those at many of the most popular owned stocks), and all are creating value via free cash flow except Sirius and Level3. (Juniper and Nextel recently began generating free cash again.) So, on these measures alone, I wouldn't short them.
Again, hedging accounts for some of this short volume, and these stocks make the top of the shorting list in part because they're among the highest-volume stocks overall. Still, it's interesting that so many of us are betting against the best (the Big Three in tech), or feeling a need to hedge our bets. It takes two to make a market, and I'd much rather be on the long side of many of these stocks, and market indexes, for most any duration.
Next week
Next Tuesday, we'll look at the second 10 most shorted stocks, where we'll see a few smaller names that investors are betting against. Yikes.
Of companies listed,Jeff holds stakes in Intel and Netflix. He reminds you, it's perfectly OK to sell your friends short (they'll understand), but not your children. The Fool, which is celebrating its 10th anniversary with "10 Ways to Make More Money Now," has a disclosure policy.
