What a short seller looks for in a stock – and what to short now

Matthew Partridge talks to Dr James Clunie of the Jupiter Absolute Return Fund about his strategy shorting stocks, and what he’s barish on now.

180925-shorting
Tesla is one of the most heavily shorted stocks

Traditional funds and investment trusts tend to have most of their assets in equities. However, some "absolute return" funds take a different approach.

Some swap between shares and less risky assets such as bonds or cash, in an attempt to sidestep market downturns. Another approach is to take both long and short positions, so returns depend far more on the manager's skill at picking stocks than the performance of the market. One such fund is the Jupiter Absolute Return Fund, managed by Dr James Clunie, who agreed to talk with us about his strategy. As part of his doctorate in management from Edinburgh University, Clunie wrote a thesis on short selling.

"It is a good time to short the market", says Clunie, whose fund is currently net short (it has more short positions than long positions). Because short sellers tend to face high constraints on their activities, they tend to be smarter than the average investor, says Clunie. So following their behaviour can be a profitable strategy, at least in the short run.

How to find a short-selling target

Clunie looks for companies with a high short interest (the number of short positions as a proportion of the total number of outstanding shares). He also likes shorting companies that have a seen a dramatic increase in the number of short positions.

However, if short interest in a company is limited, he may wait for others to make the first move. "In the past, when I've decided to go it alone on a short, we've invariably ended up losing money", he says.

He also looks for any negative catalyst that could alter people's perceptions of a company or wider sector. Internal events, such as directors leaving, firms missing their earning targets or breaches of loan covenants; or the CEO of a rival company saying industry-wide conditions are worse than expected something that could set him thinking about shorting competitors, too.

Short selling can be dangerous, of course. The potential losses are, theoretically, unlimited. But Clunie attributes his success to being willing to take losses, something many investors (on both the long and short sides) find difficult to do. However, while he always places a stop-loss on his trades his positions once they get above a certain price, he will tactically vary them to make sure other traders can't drive up the price in an attempt to get him to cover his positions. He will also close his positions if the facts change, such as the appearance of an unexpectedly positive piece of news.

What to short now...

Given Clunie's strategy of following other short-sellers, it should come as no surprise to learn that he is very bearish on the heavily shorted Tesla (NASDAQ: TSLA). Clunie accept that Elon Musk is correct that electric cars represent the future of motoring. However, he points out that there is no guarantee that Tesla will benefit from it as much as other investors think, "as there is already loads of competition". This is a big problem for investor since "Tesla's valuation is built on the assumption that it will be able to keep the market to itself". The electric car company also has taken on a lot of debt.

Another short-selling target that Clunie considers to be "really interesting" is American e-commerce firm Wayfair (NYSE:W) This company has seen its shares shoot up fourfold in the last eighteen months thanks to strong revenue growth. However, what investors are missing about this "glamour stock", according to Clunie, is that it has dismal financials. Indeed, its "balance sheet problems" are so critical that its liabilities are greater than its assets, giving it negative book value. Overall, given its negative cash flow, it's hard to see how it can service the huge amount of debt that is on its books.

...and what to buy

BP (LSE:BP)

BHP (LSE: BLT)

Rio Tinto (LSE: RIO)

Kingfisher (LSE:KGF)

Recommended

Cash rich and bored? Be careful what you do with your money
Investment strategy

Cash rich and bored? Be careful what you do with your money

As the pandemic has left many people with more time on their hands but little opportunity to spend, they have been speculating in the markets. But don…
19 Oct 2020
Jonathan Ruffer: tech stocks have become “long-duration assets”
Tech stocks

Jonathan Ruffer: tech stocks have become “long-duration assets”

As with bonds, tech stocks are now held not because of that they are, but because of what investors fear if they don't hold them, says Jonathan Ruffer…
16 Oct 2020
Investors should give European stockmarkets a second look
European stockmarkets

Investors should give European stockmarkets a second look

Investors tend to think that European stockmarkets are full of stale “old economy” firms while the US is full of fast-growing tech stocks. But Europea…
16 Oct 2020
Lessons for investors from Big Tech's previous golden era
Tech stocks

Lessons for investors from Big Tech's previous golden era

The forerunners of today's tech stock titans dominated the 1960s and 1970s. Former Xerox senior manager Dr Mike Tubbs was there and explains what inve…
16 Oct 2020

Most Popular

The Bank of England should create a "Bitpound" digital currency and take the world by storm
Bitcoin

The Bank of England should create a "Bitpound" digital currency and take the world by storm

The Bank of England could win the race to create a respectable digital currency if it moves quickly, says Matthew Lynn.
18 Oct 2020
What would negative interest rates mean for your money?
UK Economy

What would negative interest rates mean for your money?

There has been much talk of the Bank of England introducing negative interest rates. John Stepek explains why they might do that, and what it would me…
15 Oct 2020
Negative interest rates and the end of free bank accounts
Bank accounts

Negative interest rates and the end of free bank accounts

Negative interest rates are likely to mean the introduction of fees for current accounts and other banking products. But that might make the UK bankin…
19 Oct 2020