Traders: short this poorly-scoring online tutoring firm

Even if short-sellers’ suspicions are wrong, GSX Techedu is too expensive

The rally in US equities, with the benchmark S&P 500 index now up 40% from its low in mid-March, has left many stocks trading only slightly below their level at the start of this year. However, some technology shares have surged by even more as investors think that the crisis could lead to many activities traditionally carried out face-to-face being conducted online instead. 

One of these is GSX Techedu Inc (NYSE: GSX), a Chinese company that specialises in after-school online tutoring. A year ago the shares were trading at barely $10. However, by January they had risen to more than $23. They are currently at $66: a 750% rise in a single year. But the firm’s meteoric rise, which follows the implosion of Chinese companies such as Luckin Coffee, has attracted attention from short-sellers, who have argued that things are not quite what they seem. 

Do the numbers add up?

In particular, they claim that GSX is exaggerating the number of people attending its classes, with noted short-selling hedge fund Muddy Waters Research estimating that at least 70% of users are fake “online bots” (internet robots). Muddy Waters also claims that the group is understating its costs. As a result, it alleges that far from making a profit, GSX is actually an “empty box” that is making a loss.

Naturally, Larry Chen, the founder and chairman of GSX Techedu, disputes the allegations, claiming that the hedge fund doesn’t understand its business model. Still, even if you assume that the allegations are false and take GSX’s numbers at face value, the stock seems to be priced absurdly optimistically at 409 times trailing earnings. Even if earnings and revenues explode in the way that the company predicts – hardly a certainty, as once restrictions are removed people can access schools and tutors – it will still be trading on a 2021 price/earnings ratio of 80. 

Another problem that should give investors pause for thought is potential competition. GSX isn’t the only company trying to make money from online tutoring. The sector has low barriers to entry (it is easy for potential rivals to get established), so GSX will be vulnerable either to losing business or to having its profit margins squeezed. So even if online tuition expands at the rate that Chen expects, GSX won’t necessarily be the one to profit from the trend.

I think that GSX is a prime candidate for shorting. However, with the stock price doubling over the last six weeks there is always the risk that it could surge higher before it starts to fall, especially if the short-sellers end up being “squeezed” (a manoeuvre where people buy shares in a company in an attempt to drive the price up and force short-sellers to cover their positions). So I’d wait until it falls below $50 before shorting it at £40 per $1. In that case, I’d also cover the position if it rises above $75, implying a downside of £1,000.

How my tips have fared

This last fortnight hasn’t been kind to my long tips, with all five declining. International Consolidated Airlines Group (ICAG) slipped from 264p to 225p; energy giant Royal Dutch Shell declined from 1,376p to 1,314p. 

Television group ITV fell from 80p to 70p. The pubs were allowed to reopen in England last weekend, but pub chain JD Wetherspoon failed to profit; the stock slipped from 1,161p to 1,002p. 

Even equipment company United Rentals, currently my most profitable recommendation, went down slightly, from $158 to $151. Overall, the profit on my long tips fell from £2,128 to £700.

The performance of my short tips was more mixed. On the one hand two out of the three went in my favour, with health insurance broker eHealth declining from $107 to $104 while electric truck manufacturer Nikola depreciated from $70 to $49. 

However, online dating firm Match Group surged from $95 to a peak of $107. While it later fell back to $95, if you had taken my advice you would have automatically covered your position at $102, for a loss of $990.

This demonstrates that while stop-losses can prevent you sustaining large losses, they can also mean that you get stopped out of volatile positions. Counting Match Group, the overall losses on my short tips are $710.

I now have five long tips (ICAG, Royal Dutch Shell, ITV, JD Wetherspoon and United Rentals) and three short tips (eHealth, Nikola and GSX). 

With my ultimate goal being to balance my long and short tips, I plan to add some more short tips in the next few weeks. However, since my oldest position was taken out in March, I’m not going to close any of my existing tips or suggest that you adjust any of the stop-losses further.

Recommended

Has passive investing created a stockmarket bubble?
Sponsored

Has passive investing created a stockmarket bubble?

Over the past two decades, investors have been switching from buying actively managed investment funds to buying passive funds that simply track a mar…
28 Sep 2021
Why are people panicking about fuel shortages?
UK Economy

Why are people panicking about fuel shortages?

With huge queues forming at petrol stations around the country, Saloni Sardana looks at the reasons behind the fuel shortage and asks how long it's l…
28 Sep 2021
Why investors should beware of corporate waffle
Investment strategy

Why investors should beware of corporate waffle

When top executives try to retreat behind impenetrable jargon, investors should be very sceptical, says John Stepek.
28 Sep 2021
Ensign Group: profiting from US private care
Trading

Ensign Group: profiting from US private care

Nursing and care-home specialist Ensign Group should thrive as Americans age. Matthew Partridge picks the best way to play it.
28 Sep 2021

Most Popular

A nightmare 1970s scenario for investors is edging closer
Investment strategy

A nightmare 1970s scenario for investors is edging closer

Inflation need not be a worry unless it is driven by labour market shortages. Unfortunately, writes macroeconomist Philip Pilkington, that’s exactly w…
17 Sep 2021
What really causes inflation? Here’s what prices since 1970 tell us
Inflation

What really causes inflation? Here’s what prices since 1970 tell us

As UK inflation hits 3.2%, Dominic Frisby compares the cost of living 50 years ago with that of today, and explains how debt drives prices higher.
15 Sep 2021
The times may be changing, but don’t change how you invest
Small cap stocks

The times may be changing, but don’t change how you invest

We are living in strange times. But the basics of investing remain the same: buy fairly-priced stocks that can provide an income. And there are few be…
13 Sep 2021