For many investors, a bear market represents the opportunity of a generation, or perhaps a lifetime, to buy high-quality businesses on the cheap. Since the beginning of 1950, the benchmark S&P 500 has undergone 38 corrections of at least 10%, 37 of which have been completely erased by a bull-market rally. The only one that hasn't been put into the rearview mirror is the current correction, brought on by the coronavirus disease 2019 (COVID-19).
In other words, investors who choose to buy great companies with competitive advantages during periods of market weakness, and who hang on for long periods of time, tend to make money.
Short sellers have piled into these three stocks
But the thing you have to remember about investing in the stock market is that equities move in both directions. While the broader market does trend higher over the long-term, it doesn't mean all stocks move higher. Short sellers are investors who specifically make downside bets. In other words, they make money when a stock goes down and lose money when it goes up.
The upside of short selling is that it gives skeptics and pessimists a way to play both sides of the stock market. Since not every company can be a winner, there should be plenty of businesses that struggle over the long run.
On the other hand, there are two pretty notable downsides. First, gains are limited to 100% since a stock can't drop below $0, while losses are limitless given that a stock's share price has no ceiling. Secondly, short sellers are actually borrowing shares from a broker, and are therefore paying interest on what they've borrowed. Thus, short selling is typically only reserved for investors with a very high tolerance for risk and who know what they're doing.
Of course, short selling can also open our eyes to companies or trends that Wall Street really dislikes or believes are mispriced. Right now, there are three companies that stick out like a sore thumb as Wall Street's most hated, at least in terms of market value held short.
It probably comes as little surprise to most investors that electric vehicle (EV) manufacturer Tesla (NASDAQ:TSLA) is, by far, Wall Street's most-hated stock. As of March 31, 2020, 19.69 million shares of Tesla stock were held short, up 3.53 million shares from just 16 days earlier. This worked out to a dollar volume sold short of $14.37 billion. That's more than double the dollar amount held short of any other publicly traded stock.
Why the hatred for Tesla? Well, for one, there's the "Musk factor." CEO Elon Musk has frequently failed to meet initial debut deadline for new EVs and has regularly overestimated the time frame it would take for Tesla to hit certain production or profitability milestones. There's no doubt he's a visionary, but he's also been a bit of a liability and loose cannon as CEO.
Another reason to be skeptical of Tesla is the company's bottom line. On the basis of generally accepted accounting principles (GAAP), Tesla's net loss has ballooned over time. With tax credits now a thing of the past, all eyes are on the fact that Tesla's capital outlays keep outpacing its sales.
Part of Tesla's core investment thesis is also under fire. With COVID-19 pulling the rug out from beneath the oil industry, demand has fallen off a cliff. That's pushed crude oil prices to levels we haven't seen in more than two decades and dragged down the price drivers are paying at the pump. One of the primary "drivers" of buying an EV is to save on fuel costs by charging up at home. But with oil prices plunging, a major competitive edge has been tossed out the window.
While I've been wrong about Tesla before, my inclination is to side with short sellers based on the company's current $130 billion valuation.
Drug developer AbbVie (NYSE:ABBV) has also drawn its fair share of ire from Wall Street. AbbVie had 84.64 million shares held short, as of March 31, which was up a little over 3 million shares from March 15. This works to a total market value of shares held short of $6.93 billion.
The three biggest reasons short sellers have piled onto AbbVie all have to do with blockbuster drug Humira, a subcutaneously injected drug designed to treat rheumatoid arthritis, ulcerative colitis, Crohn's disease, and plaque psoriasis, to name a few indications.
First of all, AbbVie leans very heavily on Humira to drive its sales and profits higher. In 2019, Humira accounted for $19.6 billion of the company's $33.3 billion in adjusted net revenue. Being reliant on a relatively new drug isn't a big problem, but Humira is nearing the tail-end of its exclusivity cycle. When Humira begins facing generic competition, AbbVie's operating cash flow will be hit hard.
Secondly, but building on the first point, a wave of Humira biosimilars are set to hit pharmacy shelves in 2023. Although AbbVie was able to protect its bountiful cash flow by settling with eight biosimilar developers until 2023, it's all but a certainty at this point that Humira will begin facing serious pricing pressure in roughly three years.
Third and finally, there's always the possibility that the federal government tackles drug-pricing reform. AbbVie has passed along some substantial price hikes on Humira over the years, with the drug costing, on average, more than $70,000 a year. If lawmakers do make an example of drug prices being insanely high, AbbVie's Humira would be the perfect target.
Though I don't deny the challenges that lie ahead of AbbVie as it attempts to diversify its revenue stream beyond Humira, there's enough cash flow being generated to avoid shorting this stock.
Lastly, there's cable, internet, and video-services provider Charter Communications (NASDAQ:CHTR), which had 8.96 million shares held short at the end of March. Although this was down by 1.67 million shares from mid-March, it still represents $4.45 billion worth of Charter's stock being held by pessimists.
Why no love for Charter Communications, you wonder? One reason could be as simple as valuation. This is a company that managed 4.9% sales growth in 2019, but that has seen its share price triple since the beginning of 2016. While most cable and internet providers have struggled with cord-cutting and the rise of streaming services, Charter's valuation has ballooned to almost $117 billion. Based on Wall Street's consensus profit estimate for 2020, Charter is valued at a lofty 38 times this year's earnings for what'll likely be 4% sales growth.
Another reason for the high level of short interest may have to do with cord-cutting. For instance, in the fourth quarter, Charter lost 105,000 video customers and an additional 152,000 voice customers. Despite netting 313,000 net internet subscribers, the number of residential customers with all three of its bundled services fell by 13% year-over-year to 7.16 million. While internet subscribers have proved a steady source of growth, this decline in triple-play residential customers shows how fragile loyalty is among traditional cable-service providers.
My take is that Charter is doing a decent job of controlling its costs and focusing on higher-margin revenue channels where it can. Sales are headed in the right direction, suggesting its initiatives are bearing fruit. However, I agree with short sellers that 38 times its consensus 2020 profit is a steep price to pay for mid-single-digit growth that's primarily being driven by internet subscriptions.