Investors are betting more heavily against stocks of late. During the first two weeks of June, short interest swelled nearly 3%, and the short interest ratio climbed to 2.6 days from 2.1 days, according to a June 24 report from the NYSE Group.
Short interest is the number of shares that have been sold short, or sold before they're owned to create a negative position, in hopes of buying them back at a lower price and pocketing the difference. The short interest ratio is the number of days of average trading volume required to buy back the short interest.
The early June pessimism was well-timed; the S&P 500 index has fallen 8% since then. Short interest numbers for late June are due out July 12. They could show further increases, considering last week's string of dreary economic news: jobless claims are up, house sales have plunged and manufacturing growth is slowing.
The three companies below have attracted a swarm of short-sellers. Their short interest has increased 10% over the past month, to a level that represents at least 10% of their float, or number of publicly available shares. Also, their short interest ratios exceed 10 days. Ironically, such extreme pessimism can sometimes boost share prices, if it leads to a phenomenon called a short squeeze. That's where short-covering (that is, buying to reduce the short interest) pushes prices higher, leading more shorts to cover, and so on. That said, it's a risky strategy to bet against short-sellers, many of whom combine deep experience with vast financial resources and a knack for publicizing flaws in the companies they target.
Short interest increase (past month): 13%Short interest / float: 18%
Peet's Coffee & Tea (PEET) started as a Berkeley, Calif., shop specializing in dark-roast specialty beans. The company says it supplied beans to the founders of Starbucks (SBUX) during their first years of operation. Today, Starbucks is a slow-growing behemoth with a stock market value of more than $18 billion. Peet's, valued at $506 million, has a retail chain that's overwhelmingly concentrated in California, with only a sprinkling of stores in five other states, and its sales are expected to grow by more than 11% this year. Investors are clearly hoping Peet's will be the next nationwide coffee giant. They've bid the stock up to 20 times this year's earnings forecast. Sales growth at longstanding Peet's shops has been anemic in recent months, but the company is cashing in on increased distribution of packaged beans through supermarkets. The coffee has received critical acclaim; ConsumerSearch.com, an amalgamator of product reviews, lists Peet's Coffee Major Dickason's Blend as the top pick for dark roasts. It's expensive, however, at around $14 a pound, and the specialty coffee business has attracted heaps of new competition from upstarts and major chains.
Short interest increase: 26%Short interest / float: 15%
Fair Isaac (FICO) uses proprietary math to turn the data contained in consumer credit reports from TransUnion, Experian and Equifax into numbers, called FICO scores. Lenders use these scores to judge creditworthiness at a glance and to build marketing campaigns. Sales have slipped in recent years because consumers are reducing debt, not taking out new loans, and because banks aren't especially aggressive in their pursuit of new borrowers. Also, the three main credit reporting agencies have launched their own scoring firm, VantageScore. It has yet to take meaningful market share, but it has some competitive advantages, like the ability to create scores that are more even between the three agencies, and it has plenty of room to compete on price, because the scoring business has wide profit margins. Shares of Fair Isaac trade at 15 times forecast earnings.
Short interest increase: 22%Short interest / float: 20%
Diamond Foods (DMND) sells packaged nuts and microwave popcorn, and in March completed a $615 million cash buyout of potato chip maker Kettle Foods. Analysts say the acquisition should add to earnings right away, and that Kettle provides an opportunity for cross-selling because it is distributed through different stores than Diamond's other brands. That gives Diamond the rare combination of a recession-resistant product line and fast sales growth, which makes its shares popular among defensive investors. The stock's valuation isn't especially defensive, however. Shares trade at 17 times forecast earnings for the company's fiscal year ending July 2011 – ambitious, if not quite nuts.
Jack Hough is an associate editor at SmartMoney.com and author of "Your Next Great Stock."Try our powerful Select Stock Screener to discover investment opportunities that meet your criteria.
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