Most investors buy stocks in the hope that they'll go up. But those who sell stocks short actually root for their share prices go down. Borrowing shares to sell on the open market, short-sellers hope that stocks will fall so they can later replace those shares more cheaply, pocketing the difference.
Plenty of short-sellers have made huge profits by betting against struggling companies. But often, even the companies that attract the most attention from short-sellers are able to post substantial gains in their shares, causing big losses to those who sell short and have to pay much more to replace shares. Let's take a look at four companies in the S&P 500 (SNPINDEX: ^GSPC ) that are popular targets for shorts yet have performed strongly so far in 2013.
Netflix (NASDAQ: NFLX ) is the worst nightmare of short-sellers, with its stock having more than tripled so far this year. With nearly 14% of its shares sold short, however, plenty of investors think its best days are behind it.
One reason why Netflix attracts short-sellers is that it has a history of rewarding skeptics during past bull-market runs. From late 2008 to mid-2011, the stock climbed about 15-fold, but then spectacularly crashed 75% after the infamous Qwikster debacle and the price-hike that resulted from the separation of its DVD and streaming-video businesses. After spending a year in the doldrums, though, Netflix was able to restore investor confidence in light of strong growth, and now, the stock is back at those 2011 highs. Whether lightning will strike twice remains to be seen, but shorts are obviously hoping for a repeat of Reed Hastings' previous mistakes.
GameStop (NYSE: GME ) has an even higher short interest at 17%, but its stock has doubled this year. For years, bearish investors have predicted the demise of the retailer best known for its sales of used video games, on which it has built a high-margin niche business.
Digital distribution of games was supposed to both cut GameStop out of the loop as a middleman-retailer and help prevent gamers from trading in old games, effectively destroying GameStop's business model. Yet that scenario hasn't played out, and now with major game-console manufacturers finally coming out with refreshed offerings in their respective key franchises, investors expect at least a temporary boom for the retailer in the near future.
A similar story has also helped boost shares of Advanced Micro Devices (NASDAQ: AMD ) , also a favorite of short-sellers and also a big gainer this year. With short interest at 22%, the stock has climbed nearly 50% this year as the chipmaker has refocused its efforts on serving the game-console industry. With the new versions of the Xbox and PlayStation both using AMD chips, investors hope that big demand for the new consoles will help boost its own sales. Short-sellers still think that AMD's failure to make big advances in the key PC and mobile markets will eventually force its shares back to earth.
Mailing it in
Finally, Pitney Bowes (NYSE: PBI ) has thwarted short-sellers, climbing 66% despite 27% short interest. Shorts long believed that the company's huge dividend yield would eventually have to drop given the decay in its historical dominance of the postage-meter business, and that long-awaited event finally happened in April. Yet the resulting decline in its shares proved short-lived, and bullish investors have pointed to smart divestiture moves of its European and North American management-services divisions as helping to show that Pitney Bowes is turning things around. Short-sellers may yet be proven right, but for now, they've felt a great deal of pain.
Watch your shorts!
Short-selling can be lucrative, but it's also dangerous. Soaring stocks can definitely be hazardous to short-sellers' financial health, and even when the short thesis looks right, there's no guarantee the stock won't continue climbing anyway.
Of all these stocks, many believe that Netflix has the best potential to keep climbing. After all, with the average American spending as much time watching television as the average work week, the potential for profits in the space is enormous. The Motley Fool's top experts have created a new free report titled "Will Netflix Own the Future of Television?" The report not only outlines where the future of television is heading, but offers top ideas for how to profit. To get your free report, just click here!