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TheStreet Open House

Shorts Are Covering 3 Stocks Undervalued By EPS Trends

Stocks in this article: BIOS FIO PULB

One of the clearest indicators a stock is expected to price in more upside comes from short sellers. Changes in the number of shares shorted over time can give a clue as to whether investors are becoming more or less pessimistic about the name. This list covers stocks that have seen decreases in shares short in the past month, implying that investors are becoming more optimistic about the prospects of the company. Furthermore, these names appear undervalued to EPS trends. 

Allow us to explain:

Short sellers benefit when share price falls. The more they believe in the downside potential the more short positions they will initiate. If they start to think shares have more upside potential (in which case they would lose money) they will decrease their short positions. This is also referred to as short covering. For this list we screened for stocks seeing significant short covering month over month. 

Short covering data is presented in three parts; the number of shares shorted, the percentage of shares float, and the days to cover. The change in number of shares shorted month over month is most useful when put in context of the number of shares eligible for trading on the market (share float). The larger the decrease/increase, the more upside/downside is expected by short sellers. 

The days to cover ratio is defined as current short interest divided by the average daily trading volume. Intuitively, this represents the the number of trading days it takes for the short sellers to theoretically buy back all shorted stocks. The longer the days to cover, the more pent up demand there is to eventually buy back shares and exit short positions.

Next, we ran a screen on the stocks seeing a significant decrease in shares shorted for those that appear undervalued based on EPS trends.

Assuming that P/E is equal to a constant k, increases in EPS should be matched by proportionate increases in price. When they don't match up, a mispricing may have occurred. That is, these stocks have been seeing strong increases in analyst estimated EPS than increases in price over the last month.

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