Making money when short sellers miss their targets

Of the 10 most shorted stocks, only A2 Milk substantially lost value in August. Picture: AAP.

Short selling is often considered an unsporting reflection of a negative mindset. After all, aren’t we meant to love a stock or steer clear of it?

“Going short” involves borrowing stock from an institution and selling it in the hope of repurchasing the stock at a lower price and then returning it to the owner.

Like all investors, the activist “shorters” are not always right. Or if they are, they may not prosecute their case convincingly enough to the market, or the company has a plausible rebuttal. Or they may be proved right, but only long after they have closed their position.

Late last year, shares in Corporate Travel Management (CTD, $19.76) fell from $27 to $18 after VGI Partners questioned the company’s revenue recognition and global office footprint. By late February this year the shares touched $30 before retreating again, although they bounced almost 10 per cent last Wednesday after management affirmed earnings expectations.

Last year an anonymous author erroneously accused debt collector Credit Corp (CCP, $32.29) of being a payday lender, with all the accompanying regula­tory risk. While the stock fell from $27 to $24 in the ensuing month, management assuaged the doubters and the stock now trades 33 per cent above the low point.

In August, Treasury Wine Estates (TWE, $17.87) issued a feisty response after Hong Kong broker GMT Research accused the winemaker of inflating profits. The report (which was not released but widely circulated) sent the stock from $17.12 to as low as $15.28, but the losses proved to be fleeting.

Harvey Norman (HVN, $4.15) was targeted in early 2017 by a report comparing the company to a collapsed US retailer, prompting founder Gerry Harvey to dub short sellers as “criminals”. Harvey appears to have had the last laugh, with the share price improving 25 per cent since the low point of $3 in November that year.

In early May this year CIMIC (CIM, $33.35) became the latest stock to attract the ire of GMT Research, which accused the former Leighton Holdings of overstating income by $800m over two years. Given the shares have lost about one-third of their value since, we’ll declare mission accomplished for the Hong Kong-based ginger group.

Despite the headline-grabbing claims, most shorters prefer to go about their business quietly. And just quietly they’re often wrong, such as in the lead-up to the ­August profit reporting season.

Of the 10 most shorted stocks, only one — A2 Milk (A2M, $12.08) — substantially lost value in August. Shares in the unloved Dominos Pizza (DMP, $50.84), JB Hi-Fi ($35.27) and REA Group (REA, $108) increased by 13 per cent, 12 per cent and 7.5 per cent respectively after these companies released better than expected numbers. A further five stocks in the shorters’ hit parade modestly lost ground, more or less in synch with the broader market’s 3.2 per cent decline.

“When a fund manager has short sold a stock, the last thing that they would want to see on results day is a headline saying that the short-sold company has delivered net profits above their guidance, which is what JB Hi-Fi did,” Atlas Funds Management chief investment officer Hugh Dive says.

While JB Hi-Fi remains well shorted, the shorters have turned their attention to other stocks perceived as vulnerable. But, like Melbourne’s weather, commodity prices can turn on a dime.

In the industrial sector, chicken producer Inghams (ING, $3.16) is 14.7 per cent shorted, partly because of rising feedstock prices related to the drought.

Data centre operator and former market darling NextDC (NXT, $6.59) has 13.5 per cent of its register shorted, which kind of implies that demand for cloud storage has peaked and internet trawlers have stopped downloading crazy cat YouTube clips.

The long and short of it is that the strident activist campaigns do tend to hit the valuation of the target company, but not always and not forever.

With most of the stocks at least partly recovering from short-selling attacks, the rewards are there for bold investors willing to punt that the market has overreacted.

Tim Boreham edits The New Criterion.

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