Don’t fear the short-sellers: they can get it wrong too

published 7 March 2018

A professional investor tells us where he'd put his money. This week: Will Walker-Arnott of Charles Stanley selects three heavily shorted companies with underestimated business models.

News of short-selling interest in a company can cause profound levels of anxiety for loyal shareholders. There seems to be a perception, inflamed by the media, that short-sellers have superior investment intellect and an innate ability to predict the next corporate disaster. Recently the financial press has been eulogising about the hedge funds that correctly predicted the collapse of Carillion and profited significantly from its demise.

I think some balance is needed and it is important to note that short-sellers are just as susceptible to poor investment decisions as the rest of us. In fact, their errors can significantly distort share prices and create opportunities for the long-term investor.It is also important to remember that they eventually have to close their position by buying back the shares they are shorting. This can create a wave of positive momentum (a "short squeeze") for a share price that can benefit discerning investors.

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RPC (LSE: RPC) is Europe's leading plastics manufacturer. The company has ended up on the radar of the "shorties" following its aggressive acquisition policy over the last five years. Contrary to what the short-sellers believe, I think there remains a significant "roll-up" opportunity in the fragmented European plastics market. Furthermore, the company is well positioned to benefit from a move to biodegradable polymers as public concern over the environmental impact of plastics increases. The company has racked up an exceptional dividend record since listing and the valuation looks enticing as a result of short-selling.

IQE (LSE: IQE) is a Welsh technology firm that is involved in the manufacturing of compound semi-conductor wafers that are central to the evolution of 5G networks, autonomous vehicles and facial-recognition devices. The company has been targeted by short-sellers following a strong share-price performance in 2017. In particular its accounting policies have been questioned and the shares have fallen significantly from all-time highs reached in November. A number of leading City institutions have recently written supportive notes about the firm and I also believe the short-sellers have fundamentally misunderstood IQE's business model. As a result, the recent share-price dip looks like an opportunity to invest in a leading UK technology company with exciting growth prospects.

Short positions in engineering services firm Babcock (LSE: BAB) have increased in recent months as investors have become increasingly concerned about the support-services sector following problems at the likes of Carillion, Capita and Serco. I would argue that Babcock is fundamentally different from these other outsourcing companies and so not be tarred with the same brush. The company operates in some specialised areas, such as decommissioning nuclear power stations, where other companies lack the technical expertise to compete. Babcock has sustainable margins, growing dividends and an impressive order book. Short-sellers have provided an opportunity to invest in a quality company at a discounted price.