Will these heavily-shorted stocks sink further in 2018?

Paul Summers takes a look at two of the most hated companies on the market.

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As a private investor, it’s never a bad idea to monitor which stocks are subject to significant short-selling activity.

‘Shorting‘ is what happens when someone sells stock that they have borrowed from a broker on the belief that it will fall in price. Assuming this happens, the shorter will then purchase the shares back at a lower price and make a profit. It’s a risky business and something best left to experienced traders. Get it wrong and the losses are technically infinite.

Nevertheless, there’s money to be made by Foolish investors if predictions prove too pessimistic. With this in mind, let’s take a closer look at two of the most hated stocks on the market and question whether further falls really are inevitable.

Short squeeze ahead?

Holders of £1.1bn cap Greencore (LSE: GNC) have endured an awful couple of years. Priced around the 300p mark in April 2016, the international convenience food supplier’s shares have been on a downward trajectory ever since.

There was further pain in March. Despite announcing a restructuring of its US leadership team and the cessation of fresh production at its facility in Rhode Island to address operating losses, investors responded negatively to the news that adjusted earnings per share for the full year would be around 7% below previous expectations. 

With 15% of its shares currently being shorted, should we therefore expect a further drop? 

I’m not so sure. Looking ahead, the company expects decent revenue growth in the UK for the rest of the year, along with a “modest improvement in operating leverage“. The financial performance of its US operations is also expected to improve, even if currency headwinds and later-than-expected contributions from new business will impact on profit growth this year.

Since management now anticipates improved revenue and earnings from H1 of the next financial year, Greencore’s issues look fairly short term. Indeed, should the company surprise the market in a positive manner when it announces half-year numbers in May, I’d expect a ‘short squeeze‘ as traders scramble to close their positions.

Right now, Greencore’s stock changes hands for 11 times forecast earnings, suggesting a fairly decent margin of safety for prospective investors focused on the long term. The 3.5% yield is also fairly attractive.

Reduced margins

Wilmslow-based pet food and product retailer Pets At Home (LSE: PETS) is another company that has attracted shorters. With almost 12% of its stock currently being borrowed and sold, it appears that many remain sceptical of the company’s ability to maintain the kind of performance that saw it report a 7.2% rise in Q3 like-for-like revenues back in January.

They may have a point. The aforementioned rise in sales was largely the result of management’s decision to cut prices. A reduction in margins is never ideal, particularly if consumer confidence continues to stutter as a result of economic uncertainty.   

Nevertheless, I continue to believe that the company’s increasingly popular grooming and veterinary services make it a decent contrarian bet. While needing to remain competitive, it can also be argued that spending on furry companions is less discretionary than other purchases, thus making the retailer potentially more resilient than most. 

Priced at 12 times forecast earnings for the new financial year and offering a 4.8% yield, I think the market is a little too pessimistic on Pets At Home.  

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Paul Summers does not own shares in any of the companies mentioned. The Motley Fool UK owns shares of and has recommended Greencore. 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.

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