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Shorting stocks often gets a bad rap in the media, but for investors, it's one of the few ways to make money off a declining market. It also plays an important role in keeping stock values in check.
There are a number of things to look for when looking for a short sale opportunity, like quality of the business, industry trends, and valuation. I've highlighted three of my top short candidates and why I think they're worth betting against right now.
The history of retailers going from the top of the industry to the bottom is long and distinguished. Not long ago, Sears, Kmart, and J.C. Penney were big names in retail, and now they're struggling just to survive. Wal-Mart (NYSE: WMT ) is far from that kind of disaster, but it's definitely losing the cachet it once had, and as a result, same-store sales are down in the past year, which is the first sign of trouble for any retailer.
The reason this is a good short sale is that Wal-Mart is still valued as if nothing is wrong. The stock trades at 14 times trailing earnings, and with same-store sales falling in the U.S. and 50 stores being closed in Brazil and China, Wal-Mart will probably see profits fall in 2014. When a company cites food stamp cuts as one of the reasons it won't hit expectations, you know it's not the kind of stock you want to own as the economy improves.
Shorting on valuation alone is tough, and that's what makes Tesla Motors (NASDAQ: TSLA ) my highest-risk short pick. But I think the market has given way too much credit to a company that still makes a single model.
Consider that 22,450 Model S vehicles were delivered in 2013 and Tesla has a $22.9 billion market cap. That means Tesla is worth $1 million for every car it delivered during the year. Meanwhile, Ford is worth $23,678 per vehicle sold last year and General Motors is worth $18,003 per vehicle sold.
Competition has also just barely started to pay attention to the electric-vehicle space Tesla dominates. BMW is introducing its i-series to compete directly with the Model S, and Ford, Nissan, GM, and others are increasing EV development.
The EV space is something Tesla owns right now, but that's only because it's not a big enough market for the big automakers to put the attention necessary into competing in. Once they do, Tesla's margins and sales will come under pressure, and it will be very difficult to justify its $23 billion valuation. Remember that Ford and GM are worth just over twice that, and they made 2.5 million and 2.8 million vehicles, respectively, last year. That's over 100 times more than Tesla, a huge disadvantage in a business where scale matters.
The market is in love with Facebook (NASDAQ: FB ) once again, pushing its stock to an all-time high on Friday and giving it a market cap of $164 billion. Investors were excited that Facebook is learning now to send ads to mobile devices. But the problem I have with Facebook today is the "cool" factor, or, more specifically, how "un-cool" it is with teens today.
iStrategyLabs recently published a report that suggested a 25.3% decline in the 13- to 17-year-old age range and a 7.5% decline in those 18-24 between January 2011 and January 2014. Meanwhile, users 35-54 grew 41.4% and those 55 and over grew 80.4% over the same timeframe. Facebook is less cool with the kids, and as Grandma and Grandpa sign up, the younger generation will lose even more interest, moving on to the next social-media fad.
The numbers iStrategyLabs used aren't as exact as what Facebook has available and studied only the U.S., but it shows general trends Facebook itself has acknowledged. Since Facebook started in a Harvard dorm room a decade ago, it was teens and young adults who drove its growth, but now they're leaving in droves, and that's a troublesome sign.
At the very least, the downside risk is much higher than the upside potential. We saw how fast a social-media network can go bust when MySpace lost its crown to Facebook and new networks such as Twitter are already stealing users.
Investors can fall out of love with Facebook as fast as they "liked" its earnings in the fourth quarter, and at 57 times forward earnings estimates, investors who short the stock are getting a head start with such a high valuation.
Shorting stocks can diversify your portfolio
These are three great short opportunities for investors with a long timeframe to ride out the day-to-day waves of the market. A few short positions can also add diversity to your portfolio and give you a way to make money if the market goes down.
Tell us what your favorite short picks are in the comments section below.
A stock you shouldn't be betting against
Those are a few short picks but if you aren't ready to sell the sell button, The Motley Fool's chief investment officer has selected his No. 1 stock to buy in 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.