What 'Short' Interest Says: Analyst's Toolkit
Analyst's Toolkit is a weekly feature that assesses stocks, bonds and funds by using measures that can give different perspectives on valuation. Come back every Wednesday for fresh insights into analyzing securities.
BOSTON (
) -- Shorting stocks, or betting on a decline, is considered by some to be reckless -- meddling, even. But for investors in it for the long haul, the amount of short interest is helpful because it's an indication of a company's value and its stock's possible direction.
To short a stock, a short seller must borrow shares from a broker and sell them in the market. To cover the short position, the short seller purchases the stock and returns it to the broker. Investors, who short stocks they think are overvalued, make a profit on the difference between the two prices.
The higher the short interest, the more people think the price is too high.
There are two key statistics to consider when evaluating short interest. (That information is available on TheStreet.com's company-profile tab. Here's
General Electric
, for example.) The first is the short ratio, which is the amount of shares shorted divided by the average daily volume of trading. That statistic shows how many days of trading it would take for the entire short interest to be covered. A high number indicates a lot of short interest or thin trading. High short ratios can lead to a so-called short squeeze, in which a large number of short sellers try to cover short positions at the same time, flooding the market with "buy" orders and artificially pushing up the price of the stock.
Atheros
(ATHR)
is a good example of a stock with a high short ratio. With a ratio of 9, the network-equipment maker is far above competitor
Broadcom
(BRCM)
, which has a ratio of 2.9. That suggests Atheros' current value is rich. Atheros' stock has risen 68% over three months, and Broadcom is up only 10% over the same period.
Sometimes short-interest ratios are about the same for an entire industry. If it's company-specific, take a closer look to understand why. In addition, short interest can rise or fall, suggesting the shares could be headed down or up.
A second short-interest metric is the short percentage of float. That is simply the short interest divided by the stock's float, or the shares outstanding minus restricted stock. Short percentage allows investors to quickly see the magnitude of a short position. A higher number means more shares have been sold short.
Comparing industry competitors with that metric allows investors to see which holdings may be overvalued. In the cell-phone industry, the short percentage shows a stark contrast in the market perception of prices.
Apple
(AAPL) - Get Report
,
Research in Motion
(RIMM)
and
Motorola
(MOT)
have percentages ranging from 1.8% for Apple to 2.8% for Research in Motion -- quite low. Nokia's is less than 1%.
Palm
(PALM)
, however, looks to be a dog in the eyes of short sellers. With a percentage of more than 30%, there is heavy speculation the shares could be in for a correction. Palm's stock has surged more than 90% during the past year.
Netflix
(NFLX) - Get Report
and
Blockbuster
(BBI) - Get Report
may be miles apart in terms of outlook, with Blockbuster fading away and Netflix becoming a dominate player in consumer-media rentals, but in terms of short interest, they are similar.
Netflix has only a slightly higher short percentage and ratio of 22.6% and 11.1, respectively, to Blockbuster's 17.8% and 10.7. However, Blockbuster's share price is a lowly $1.27 versus Netflix's more than $40. Given its low price, Blockbuster may soon see a short squeeze, assuming the shorting crowd isn't simply betting on a bankruptcy, because the shares don't have much further to drop.
-- Reported by David MacDougall in Boston.
Prior to joining TheStreet.com Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.
