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What are the metrics related to short-selling, and how do you find them? Thanks, M.G.
Short-selling is pretty much a backwards form of investing. Instead of buying a stock with the intent of selling it at a higher price, you borrow a stock (through your broker) and immediately sell it. If the stock falls to your target, you then buy it at the lower price and return the shares to their rightful owner (probably through your broker) for a nice profit.
But watch out! There's danger involved.
While there's no limit to shorting a stock -- other than the limits on your own ability to tolerate a loss -- there's always the possibility that the owners of the stock could ask that the shares be returned immediately. When they're orchestrated en masse, these so-called "buy-ins" are considered a short squeeze. They cause the stock's price to rapidly rise.
One way to assess whether a stock is heavily shorted is by viewing the magnitude of its short ratio.
The short ratio, or short-interest ratio, is the number of a company's outstanding shares that are sold short, divided by the average daily trading volume. Generally speaking, the higher the short ratio, the greater the pessimism about a stock. The ratio is also referred to as the "days-to-cover ratio" because it shows how many days it will take short-sellers to cover their positions.
It should be noted that some contrarian investors view the short ratio in reverse. In their opinion, a high short ratio indicates a bullish outlook for a stock, because it means a large number of short-sellers will be forced to cover their sale at some point, perhaps forcing a squeeze.
Those who take the contrarian approach are usually bullish when the short-interest ratio approaches 5 -- because it would take a long time to buy back those shares -- and bearish if it declines toward 3.
Yahoo! Finance offers short interest on its key statistics page. Furthermore, most exchanges provide online tools to measure monthly changes in the short interest of a particular stock.
In a recent article you questioned whether stock splits were a good thing, noting that when they split 2-for-1, you really have the same value, just more shares. But what about the dividend payment, doesn't that increase? Thanks, P.C.
The dividend payment does not increase just because a stock split increases the share count. But before I explain why that's the case, let's quickly review stock splits.
When a company's stock price gets very high, some investors may shy away from purchasing it. In an effort to lure investors with a lower price tag, companies often split their stock into two or more equal parts. For example, if XYZ Co.'s stock climbs to $120, the company may announce a 3-for-1 stock split, meaning shareholders would get three $40 shares for each $120 share they hold. The underlying value remains the same.
In essence, the "six of one, half dozen of the other" model holds true. But investor sentiment often makes it seem different. Some investors, for example, may like to purchase shares in 50-share or 100-share lots, and a big price tag for one stock may keep them away. A stock split gives these smaller investors a psychological boost to buy the stock.
A company's dividend is affected by the split ratio, though companies often raise their dividend after they split the stock.
But once again, please remember that there is no value creation in a stock split, dividends, earnings or otherwise. It's just a matter of simple math.