Volatility as a Way of Life

Disney (NYSE:DIS) and Six Flags (NYSE:PKS), look out! There's a new roller coaster in town, and you needn't even leave the comfort of your home computer to ride it.

Illinois kefir maker Lifeway Foods' (NASDAQ:LWAY) stock has taken investors for a wild ride over the past few months, rising from lows around $7 (split-adjusted) in early February, when I first profiled it on these pages, cresting at more than four times that price on April 13, then falling back to $11.85 as of yesterday. Along the way, short interest in the company has skyrocketed and now stands at more than 25% of the float.

I find that level of short interest imprudent, but financially tempting as an investor. While personally, I sold my own holdings long ago as Lifeway's stock price flew past my estimate of its intrinsic value, I am starting to get interested again.

In my view, Lifeway's "shorts" are playing with fire today, just as much as Lifeway longs were as recently as a month ago. Short sellers might be well-advised to review Bill Mann's rules for prudent shorting of companies, as outlined in Betting Against the House: Shorting for Profit (yours free for trying a subscription to our small-cap newsletter Motley Fool Hidden Gems). To cite just a few of Mann's suggestions, you probably do not want to short a company unless it has:

• Minimal profits
• High short interest
• Massive stock option issuances
• Unintelligible financial statements
• Massive debt
• Excessive valuation

Lifeway scores two hits out of those six criteria: high short interest and high valuation. And it is a safe bet that the latter is the primary reason for the former. But is a high price sufficient reason to short this stock? I say no.

Lifeway fails -- which is to say, passes -- all the other tests. It sports double-digit returns on equity and assets, and operational and net profitability. Management does not dilute outside shareholders. Its SEC filings are written in plain English and, at under 20 pages for the 10-K, are an easy read. Plus, the company is sitting on $10.5 million in net cash.

While the company's EV/FCF ratio of 75 is still too rich for my blood, I admit that I am getting interested. If Mr. Market and his pals, the short sellers, would just be kind enough to discount its price a bit more, I will gladly buy another ticket on this ride.

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Fool contributor Rich Smith owns no shares in any of the companies mentioned in this article.