SAN DIEGO (TheStreet) -- It happens all the time: Investors get blindsided and wonder why.
Classic case: Five Below (FIVE). This is one I've been hearing about as a disaster-in-the-making for months, but hadn't yet focused on or written about.
Still, it's a good case study, and with 21% of its float sold short, it appears investors shouldn't have been surprised by its earnings warning.
What do the shorts see that investors obviously don't?
I checked with one today who focuses largely on retailers and has been among those sounding the siren on Five Below.
Here's a summary of what he said. If nothing else it provides a good look at why sometimes the shorts know before the company:
"For me it was a number of factors that began with the jailbreak of insider sales. Insiders sell all the time, but to my knowledge I had never seen such a large percentage of shares outstanding sold in such a short period of time. FIVE insiders sold over 50 percent of shares out in, I believe, about 14 months.
"But for me the number one factor is what I saw when I analyze a retailer: The gross margin return on inventory. This metric encompasses both inventory and gross margin. Inventory at FIVE has been increasing faster than either revenue or unit growth.
"That caught my eye and then last quarter gross margin declined. If you get too heavy on inventory right into sagging sales, you will have to discount or get caught with a bunch of bad inventory.