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Hedge funds expect Royal Mail’s share price to fall. This is what I’d do now

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One thing I always keep an eye on when researching stocks is the list of the most shorted stocks in the UK. These are the stocks that hedge funds and other sophisticated investors are betting against heavily. It pays to be cautious with heavily-shorted stocks. Often, they go on to lose a lot of their value.

Looking at the current list of most shorted stocks, one company stands out. That’s Royal Mail (LSE: RMG). This is a stock that’s owned by a large number of private investors in the UK. Worryingly, it’s currently the fifth most shorted stock on the London Stock Exchange with 7.7% of its shares being shorted. This means that plenty of very smart investors expect Royal Mail’s share price to fall.

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So, what’s the best move for private investors now? Is it time to sell Royal Mail shares?

Hedgies expect Royal Mail’s share price to tank

It’s not hard to see why hedge funds expect its share price to fall. Recent full-year results, issued on 25 June, were ugly. For the year, adjusted profit before tax was down 31% to £275m while basic earnings per share (EPS) fell 36% to 19.6p. The board decided not to recommend a final dividend for 2019-20.

Meanwhile, guidance for the near term wasn’t encouraging. Royal Mail provided two potential scenarios. In the worse of the two, which assumed a UK GDP decline of 15% (Q2 GDP was down 20.4%), it said UK revenue could be between £500m to £600m lower year-on-year.

Clearly, Royal Mail is experiencing challenges right now. It could be a while before the company turns things around.

Broker price targets: well below the current share price

Looking at City analysts’ views on Royal Mail, the outlook is quite bearish. For starters, analysts are continuing to downgrade their EPS forecasts. Over the last month, the consensus forecast for the year ending 29 March 2021 has fallen about 2p to -19.1p. This kind of downgrade activity could put pressure on Royal Mail’s share price.

Secondly, plenty of analysts have 12-month price targets well below the current share price. Liberum, for example, which rates the stock as a ‘sell’, has a price target of 115p. That’s about 45% below the current share price. Meanwhile, Credit Suisse has a target of just 94p. That’s about 55% below the current share price. The median broker share price target is 161p – about 24% below the current share price.

I’d sell

Royal Mail’s share price has enjoyed a brief rally recently, rising from about 160p to 212p over the last six weeks or so. Yet the outlook for Royal Mail looks quite grim at the moment, in my view. I wouldn’t be surprised to see the share price fall again.

Weighing everything up, I’d be looking to sell into any share price strength. I’d then move the proceeds of the sale into high-quality, resilient businesses with strong growth prospects.

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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.

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