The Short Way Around

The market’s bull run naturally has been a disaster for most short-sellers--those traders who bet that stock prices will fall, not rise. Yet bruised or not, they’re still putting money on scores of stocks they believe are headed lower.

How can you tell? Each month the major exchanges publish lists of stocks that have been shorted, and one can quickly see which issues are the favorites of short-sellers.

Does that mean these stocks are considered losers? Hardly. Many also have plenty of cheerleaders on Wall Street and may be targets of short-sellers only because the stocks have soared in price lately.

So investors mulling a contrarian strategy might want to make their own bet: that the short-sellers are going to be wrong again.

First, here’s how short-selling works:

An investor typically borrows the stock from a broker and immediately sells it in the market--let’s say XYZ Corp., sold at $50 a share. Now the short-seller waits--and hopes that the price will drop. If it does, say to $40 a share, the short-seller buys it back at that price, returns the shares to the broker and pockets the $10-a-share difference (minus transaction fees, of course).

What if XYZ goes up instead? The short-seller is underwater.

When a stock is shorted but the short-seller has not yet bought it back, or “covered,” the shares are known as “short interest.”

Nearly all stocks are shorted to some extent; even blue-chip issues such as Walt Disney Co. (ticker symbol: DIS), Wal-Mart Stores Inc. (WMT) and General Electric Co. (GE) are shorted, and their short interest totals in the millions of shares each month. Even so, the shorted shares amount to a small percentage of those companies’ total shares outstanding.

And in many cases, short sales of these stocks are a kind of insurance purchased by money managers who aren’t so much convinced that the shares are headed lower, only that they want to lock in current profits by hedging their bets in case those stocks go up or down. Some big-name stocks are shorted also because investors simply believe the stocks have gone up in price so much that they’re due to fall back.

*

A better way to gauge whether a stock is a favorite of short-sellers is to measure its short interest against its average daily trading volume, what’s known as its short-interest ratio. The higher the ratio, the more it signals that the stock is high on the short-sellers’ lists. The ratio is the number of days it would take for the short-sellers to cover their positions at the average daily volume.

To be sure, even that ratio could be skewed if a short-seller takes a major short position in a stock that’s lightly traded. Then the stock’s short-interest ratio would naturally jump.

Regardless, even stocks with high short-interest ratios have their followers, and here are four to consider:

Stryker Corp. (SYK) just moved to the New York Stock Exchange from the Nasdaq market, and brought a big short position with it. As of Aug. 15, the Kalamazoo, Mich.-based producer of orthopedic products and surgical instruments had short interest that would take a whopping 86 days to cover if Stryker continued trading at its average daily volume for the month.

At a recent $41.38 a share, the stock has soared 68% over the last 12 months--which is one reason why the shorts are circling. But analysts Thom Gunderson of Piper Jaffray and Robert Faulkner of Hambrecht & Quist are still recommending the stock because, among other things, Stryker has a two-decade record of 20% earnings growth year over year.

Faulkner said short-sellers probably are convinced that Stryker can’t keep generating the revenue growth to sustain its historical pace of higher profits. The bears got ammunition recently when Stryker’s purchase of a medical products distributor, along with foreign currency fluctuations, impinged on the company’s sales.

But excluding those items, “you’ll find growth of 15% to 18% in their base business, which is perfectly adequate to drive their 20% growth” in earnings per share, Faulkner asserted.

*

Another popular short that still has supporters is North American Vaccine Inc. (NVX), a fledgling maker of vaccines for preventing infectious diseases. The $23.19-a-share stock, which trades on the American Stock Exchange, has been fairly flat for several months, and for the six months ended June 30, the Beltsville, Md.-based company lost $23 million on revenue of only $2 million as research and development costs far exceeded its product sales.

It’s easy to see why the shorts like it. At $23.19, North American Vaccine has a market value of $733 million, or more than 150 times its annual sales.

Nonetheless, David Crossen of Montgomery Securities is urging clients to buy the stock. North American Vaccine has a new vaccine for children that he expects will be approved by the Food and Drug Administration within two months, enabling the product to reach the market by year’s end.

Also, Crossen said he expects the company to use this vaccine as the base for “sequential development of additional vaccines.”

Then there’s Wyman-Gordon Co. (WYMN), which has one of the highest short-interest ratios on the Nasdaq market (40 days). The North Grafton, Mass.-based maker of structural components for commercial jetliners, at $27 a share, has surged 50% since February--a sign to the short-sellers that a pullback may be coming.

But one reason for the stock’s spurt is that Wyman-Gordon’s profit doubled in its fiscal year ended May 31, to $50 million on revenue of $609 million. And Peter Arment of JSA Research Inc. still has a “buy” on the stock because the company’s “business is overflowing, as far as we can tell.”

Wyman-Gordon also has long-term pacts with the major manufacturers of jet engines to produce components for them, and that’s why Arment is forecasting a year-end price for the stock of $39 a share.

*

Another Nasdaq stock, Granite Broadcasting Corp. (GBTVK), has been making money for the shorts by dropping in price, and the bears obviously expect more weakness because they’re still heavily shorting it. Granite’s nonvoting stock, at $11.50 a share, has dropped 5% over the last 12 months.

But the company, a New York-based operator of TV stations in states scattered nationwide, has a “buy” recommendation from Paul Sweeney of Salomon Bros., in large part because he expects further consolidation among station operators. Also, “we think 1998 is going to be a good year for TV in general and Granite in particular” because advertising spending should be robust thanks to political elections and the Olympics next year, he said.

One other note concerning all of these issues: Oddly enough, having a lot of short interest in a stock can be a bullish factor for buyers of the shares. That’s because if the stock’s price starts to climb, short-sellers might be prompted to throw in the towel and cover their positions to avoid further losses. And when they cover, they have to buy the shares--giving prices even more of a boost.

*

Times staff writer James F. Peltz can be reached at james.peltz @latimes.com

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

SHORT HOPS?

These stocks are popular with short sellers--those who borrowed the shares, sold them, and now hope to buy them back, or “cover” them, at a lower price to reap the difference. Some analysts recommend investors buy these stocks even though they have large “short interest ratios.” The ratio is the number of days it would take for the short sellers to cover a stock that’s been sold short but not yet repurchased, based on the stock’s average daily trading volume.

*--*

Ticker Recent Price change Short interest Stock symbol price from 12/31 ratio at 8/15 North American Vaccine NVX $23.19 -5% 99 Stryker SYK 41.38 +39 86 Brooke Group BGL 5.69 +14 78 Wyman-Gordon WYMN 27.00 +22 40 Granite Broadcasting GBTVK 11.50 +8 32 WFS Financial WFSI 20.00 +1 31

*--*

Sources: New York Stock Exchange, American Stock Exchange, Nasdaq, Bloomberg News