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Fortune November 25, 2002 , page 192 AGAINST
THE GRAIN A Short Path to Trouble Beware of analysts touting stocks that may get 'squeezed'
higher. That's a loser's game.
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Call it a
sign of desperation, or just a sign of the times: One of the most popular
games from the bad old days of a few years ago, squeezing the short-sellers,
is back in vogue as a reason to buy stocks. Consider
these examples from recent weeks. Goldman Sachs
analyst Steve Kent reiterated his love affair with Marriott by writing that
"a 'short squeeze' may be imminent." Morgan
Stanley analyst Mark Edelstone cited a "large
short position" as part of his recent pitch for Silicon Laboratories, a
maker of cellphone components. And
despite a tumble in the price of Nautilus, which makes the Bowflex exercise machine, Eric Wold
of RTX Securities said a "potential short-squeeze situation" could
pump up the stock. Yet squeezing
shorts is anything but a sure-fire way to make money. A
short squeeze, for the most part, occurs in heavily shorted stocks when
short-sellers are forced to cover (buy back the shares that they have sold)
because long investors are bidding the stock up. (Shorts
bet against stocks by borrowing shares and selling them, with the hope of
buying them back at a lower price.) The fast-rising
prices force shorts to buy shares quickly, which makes the stock soar. That forces even more short-covering,
creating the squeeze. What could
cause this chain reaction? The rightful owners of
the shares, often institutional holders like mutual funds, might demand them
back, often in an effort to cause a squeeze. Or the
short-sellers might have been premature, or perhaps they misjudged the fundamentals. (It does happen.) Or maybe the
shorts panic on the release of what looks to be good news. However,
for all but the nimblest traders, squeezes can be a big loss waiting to
happen. "Playing a short squeeze," says
Barry L. Ritholtz, chief market strategist for the
Maxim Group, "is a game for only the very brave and very stupid." There is, after all, no guarantee a squeeze will
happen. Even if one does occur, and the fundamentals
prove to be as bad as the shorts had claimed, the slide back down can be
faster than the rise. What proponents of short
squeezes often forget is that short-sellers have a natural incentive (their
own profit-taking) to buy a falling stock. When they're gone, or squeezed out, that buying cushion
disappears and squeezed stocks often land with a thud. Just ask
anybody trapped in the squeeze of Calpine, an
independent power company whose stock was catapulted from $45 to as high as
$57 on a short squeeze in March and April 2001, before fundamentals caught up
with the story; it now trades at around $3. But the
ultimate risk for investors hoping for a quick profit is that they get lured
into the end of a frenzied run-up--like the ones that boosted the stocks of circuitboard-maker Act Manufacturing, software maker
Lernout & Hauspie, or auto transport company ACLN, which at their peaks
traded at $72, $73, and $50, respectively. Act
Manufacturing has since filed for bankruptcy and fetches less than a penny on
the pink sheets after being delisted by Nasdaq. ACLN, accused by federal
securities regulators of fraud, was booted from the New York Stock Exchange
and trades for less than a quarter on the pink sheets. And
Lernout & Hauspie has been liquidated. At the least,
those playing the squeeze should entertain the notion that shorts might be
right. According to a recent study published by the
Journal of Finance, the higher the short interest, the more likely a company
is to fall. Heavily shorted stocks "experience
a significantly higher incidence of liquidations or forced delistings" than similar-sized firms with low short
interest, the report says. "Large short
positions are bearish signals." Which brings
us back to Marriott, Silicon Labs, and Nautilus, all magnets for shorts. Marriott, the shorts believe, suffers from a mix of bad
business conditions as well as aggressive accounting and
too-close-for-comfort dealings with related parties. While
conceding that business is weak, as it is for most hotel operators, Marriott
insists that its accounting and related party dealings are appropriate. The knock on Silicon Labs, meanwhile, is that it's
facing tough competition. The proof is in the
numbers: Fourth-quarter revenue growth, based on the company's guidance, is
tumbling. Finally, the shorts are betting Nautilus
(a company I've written about on The Street.com for months) will suffer as
demand for the Bowflex, its main product, weakens. Its stock tumbled 43% on Oct. 16 after the company
warned of a possible slowdown, yet some Nautilus fans are counting on a
squeeze to reinflate the stock. Maybe
they'll get their wish, but if the shorts wind up being right about any of
these companies, investors playing for a squeeze may instead wind up getting
squashed. |
