Short-selling is a vital component of healthy equity markets. Shorts may not be popular, but they help keep Mr. Market on his toes. Even our own Motley Fool CAPS system emulates buying and shorting via thumbs-up and thumbs-down calls, because a bearish investment thesis that you can't take action on is no thesis at all.
Pick a stock, any stock at all, and somebody out there will have sold a few shares short. Some tickers attract bears because their valuation is running away from reality (as the bears see it, anyway). Other times, shorting can be a simple hedge against drastic market swings.
Not even the Dow Jones Industrial Average's (^DJI -0.98%) elite club of 30 blue-chip giants is immune to shorting.
Examples, please!
Bank of America (BAC -1.07%) is currently the least shorted Dow stock. It would take about a full day at average volume to cover every short bet on the megabank right now. The stock has gained 39% over the last year on a dividend-adjusted basis, crushing the Dow's 11% gain. And it did this without attracting a den of bears. That's a testament to how far the stock had been depressed before this huge skyward run. Even the pessimists can't find much to complain about.
At the other end of the spectrum, you'll find Johnson & Johnson (JNJ -1.15%) fighting off short-sellers tooth and nail. Covering these bearish bets in a hurry would absorb nearly 10 days of J&J's average trading volume. That's more than twice the "days to cover" of the second-place finisher.
The health care titan has beaten the Dow with a 21% one-year price gain, but not without controversy. The company is currently under fire for a large-scale recall of hip replacement devices. Analyst firm Credit Suisse recently downgraded the stock from a "neutral" recommendation to "underperform," citing overheated valuations relative to other medical stocks. Many bears agree, and 3.7% of J&J's market float was sold short two weeks ago.
All that and a bag of chips
In second place, semiconductor veteran Intel (INTC 1.77%) would cover its shorts in 4.5 regular trading days, with 4.2% of its shares having been bet on bearish outcomes. And it's not a valuation play at all: Intel shares have lost 21% of their value year over year, and they trade for less than 10 times trailing and forward earnings.
Intel is the victim of a rapidly changing market, both in enterprise-class computing and consumer devices. Tablets and smartphones are pulling the rug out from under regular laptops and desktops. Intel is late to the mobile game, so this change hurts until the company can get traction for smartphone strategy.
On the other hand, the same trend also fuels a rolling boil under the server segment. All of these mobile gadgets are pretty useless unless you feed them apps, songs, movies, and other data from a data center somewhere. Let's say Intel's mobile ambitions don't work out. That still leaves the company with a vibrant server market.
Smaller rival Advanced Micro Devices used to be a threat in that space but is fading in Intel's rearview mirror due to weak execution and some boneheaded management moves. ARM Holdings (ARMH) wants to expand its mobile dominance into the data center as well, but it's hard to find an ARM-powered server system today.
In this case, I think the bears are dead wrong. If I were a betting man, I would place far lower odds on Intel eating ARM's lunch than I would on the opposite scenario. But I'm an investor, not a gambler -- so I own Intel shares instead.
A huge short position can be a warning sign, but only if the bearish thesis makes sense. Just because J&J attracts more short sales than Bank of America doesn't necessarily mean that one stock is great and the other one is broken. Serious investors should use shorting statistics as a starting point for deeper research.
