The recent ‘shock’ slump in Carillion’s share price starts to make a lot more sense when you consider it’s been the most shorted stock on the market for some time. As such, surely it makes sense for prudent investors to also avoid those companies out to steal the outsourcer’s crown?
Second place goes to…
With 18% of its stock currently being shorted, online grocery retailer Ocado (LSE: OCDO) is the stock looking to occupy the role of ‘most hated’. Some may be puzzled by this fact, especially when recent results and speculation of a bid from Amazon are taken into account.
To recap, in the 26 weeks to 28 May, the company recorded a 12.5% rise in group revenue to just below £714m. Order volumes also grew by almost 16% to an average of 260,000 per week.
Perhaps the biggest recent news from the company, however, was the announcement of a partnership with a mystery European retailer to use the former’s Smart Platform. The prospect of this being the “first of many” only served to compound investors’ excitement.
So, should we be buying rather than avoiding the shares? On an eye-watering forecast price to earnings (P/E) ratio of 225 for the current financial year, I think there’s only one answer to that.
Not only is purchasing a company’s stock on takeover rumours inherently risky, any business trading at this kind of valuation is surely destined to disappoint eventually. While I share the company’s belief that the trend for grocery shopping online is likely to continue, the sheer number of question marks remaining over its strategy to expand overseas make it hard to regard the £1.9bn cap as anything but a less-than-solid investment.
With pre-tax profits falling 18% to just £7.7m over H1 and levels of debt rising to £102m, I still think Ocado warrants its current position.
And in third…
Following closely on Ocado’s heels and holding the dubious honour of third most shorted stock is Morrisons (LSE: MRW). Again, some might regard this as strange considering recent results appear to show a recovery in the FTSE 100 constituent’s fortunes.
In addition to this, Morrisons recently announced that it will become the sole UK wholesale supply partner to convenience chain McColl’s — a deal that will bring total annualised wholesale sales to over £700m and begin contributing to profits in the 2018/19 financial year.
Trading on 20 times forecast earnings, the shares are clearly more sensibly valued that those of Ocado and come with a 2.4% yield. Nevertheless, with competition only likely to intensify in the sector if inflation continues to rise, and the company still lagging Tesco and Sainsbury in terms of market share, caution is advised. As always, any investment decision should be based on your attitude to risk, required rate of return and time horizon.
There’s a caveat to all this. While a large amount of shorting activity suggests that private investors may be better off avoiding a particular stock, it’s also the case that hated stocks occasionally surprise on the upside, such is the unpredictable nature of the market. In such a situation, you can expect a serious rise in the shares as short positions are closed, supported by new investors simply buying the shares.
Is this a risk worth taking with Ocado and Morrisons? Only you can decide.
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Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.