Avoiding big losses is one of the keys to being a successful stock market investor. But that’s not always easy – even top investors such as Neil Woodford can get it wrong occasionally. However, one strategy that can help you avoid big losses is to steer clear of companies that are being heavily shorted. These are companies that hedge funds and other sophisticated investors believe have problems and could see their share prices fall.
Today, I’m looking at the three most shorted stocks in the UK, according to shorttracker.co.uk. I’m definitely avoiding this trio for now.
Pets At Home
Pet care business Pets At Home (LSE: PETS) is currently the most shorted stock, with 13.2% short interest. Despite the fact the stock has fallen from over 300p in late 2015, to just 121p today, hedge funds are clearly still quite bearish on the £593m market-cap stock. So what’s wrong with the company?
One key issue with PETS is that over the last year the group has been forced to cut its prices, which has lowered margins and profits. For the year ending 29 March, total gross margin fell to 51.7%, from 54.2% the year before, with underlying basic earnings per share plummeting 11.2% to 13.5p. Looking ahead, analysts expect a further decline in earnings this year.
Trading on a forward P/E of 9 and offering a dividend yield of 6.2%, its shares look cheap, but I’m not willing to bet against the hedge funds right now.
The second-most shorted company in the UK, with a 12.4% short interest, is Restaurant Group (LSE: RTN), which owns over 500 restaurants including the brands Frankie & Benny’s, Chiquito and Coast to Coast. Like PETS, the stock has endured an awful run, falling from near 700p at the start of 2016, to just 267p today.
With Brexit uncertainty and the extreme weather we experienced earlier in the year, trading conditions for this hospitality group have been challenging. For example, for the 20 weeks to 20 May, like-for-like sales declined 4.3%, and total sales fell 3.1%. Analysts expect earnings per share to fall by around 5.4% for the full year.
The stock currently trades on a forward P/E of 12.7 and offers a prospective yield of 5.9%, but I’m not tempted by these metrics given the large short interest.
Lastly, with 11.9% short interest, we have Debenhams (LSE: DEB), which I’ve warned investors about before. Over the last five years, Debenhams shares have lost nearly 90% of their value, falling from 107p, to 13.5p today. Yet hedge funds continue to short the stock relentlessly which is not a good sign. Could the department store go the same way as House of Fraser?
Debenhams’ recent performance has been concerning. In June, the group released a profit warning advising investors that pre-tax profit for the year is expected to be between £35m to £40m, a long way short of the £50.3m consensus estimate at the time. Ratings agency Moody’s has recently downgraded the group’s credit rating as a result.
Debenhams shares currently trade on a forward P/E of just 5.3 and offer a prospective yield of 6.6%. However, I’ll be steering well clear.
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Edward Sheldon 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.