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I think these 2 hated high-yielding stocks could still make you rich!

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A list of the top shorted stocks in the UK is always illuminating. Basically, it’s a row of ugly ducklings waiting to quack.

Duck soup

International defence, security, transport and energy business Ultra Electronics (LSE: ULE) is the ugliest of the lot, shorted by 12.6% of investors, according to ShortTracker, followed by Arrow Global Group (LSE: ARW) at 12%.

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Personally, I don’t short stocks, and it’s not something we at the Fool are into. We prefer to buy nicely valued dividend-paying stocks, or low-cost index trackers and investment trusts, and hold them for the long term. However, it’s always interesting to see which stocks investors expect to fall rather than rise, as you may have them in your portfolio. If so, take a good, sceptical look at them.

On the defensive

Ultra Electronics has struggled lately, falling 21% in the past six months. That’s despite publishing a well-received trading statement in December, which showed strong order inflow and underlying revenue growth, but a constrained supply chain. City analysts expect earnings to have fallen 11% when the group’s 2018 results are published, but rise 15% in 2019, and 7% the year after. Revenue growth looks steady too.

You won’t be surprised to see it’s available at a relative discount, just 11.2 times earnings, with a PEG of 0.7. The forecast yield of 4% is covered 2.3 times, and the return on capital employed is 27%. These numbers all look healthy.

However, there could be stuff here we don’t know, with an unimpressed Barclays recently analysing five years of the group’s accounts. It warned Ultra’s underlying profits tended to include low-quality income items but exclude one-off costs, while acquisitions have “disappointed”. Short sellers have clearly taken note.

Off target

Given the heavy shorting of European-focused credit collection specialist Arrow Global, you may not be surprised to see its share price is down 50% in the past year. Yet there’s been good news in that time. For example, in November it reported strong profit and core collection growth for the nine months ended 30 September, while core collections and assets under management both rose by similar percentages.

Some were concerned to see founder & CIO Zachary Lewy offload a massive £4.27m worth of shares last March, and another £455,809 in May. Wise man. He got a much better price than he would get today.

Wide of the mark

Arrow hits the mark in so many ways. It trades at a bargain basement 4.1 times forecast earnings, with a PEG of 0.2 and yields a whopping 9.1% with cover of 2.7. Three years of double-digit earnings growth have been forecast, so the City isn’t completely down on this stock. I imagine investors are primarily worried about the impact a potential economic slowdown will have on its collections business, especially with Europe apparently sliding towards recession. Operating margins are forecast to fall sharply, down from 33% to 23.8%.

I wrote a gushing review after its positive November results but the share price spike didn’t last. I’m approaching with much greater caution today. Its numbers look tempting but are there hidden threats?

Ultra and Arrow could still prove rewarding, if you understand the risks.

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Harvey Jones has no position in any of the 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.

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