10 stocks I’m avoiding like the plague

I believe successful stock picking is not only about choosing winners, but also avoiding losers, particularly those that result in a total loss.

On the losers front, some of the biggest blow-ups come from the uncovering of fraud, or a failing business masked by complex accounting, or a deteriorating debt burden. The trouble is, the average private investor doesn’t have the resources or time to investigate such things in great depth.

However, some astute hedge funds do. And if they uncover a badly, or fatally, flawed business — before its failings become generally known — they can make money by short selling (‘shorting’) the stock. The further its share price falls, the more profit they make.

As I explained in an article last Christmas Eve , steering clear of the most heavily shorted stocks has helped me to avoid a number of 100% wipeouts over the years. In that article, I also listed the top 10 shorted stocks on the London market at the time.

Today, six months on, I’m going to look at how those stocks have performed, and also at the current top 10 shorts. The table below shows the performance of the Christmas Eve cohort.

The average fall of the 10 stocks is 14%, over a period in which the FTSE 100 has gained 11%. There have been some risers, notably Pets at Home (+59%), but I’m happy to have blanket-avoided the 10 stocks, particularly the 100% wipeout at Debenhams.

In addition to delisted Debs, four of the above companies are no longer in the top 10 shorted list today, although I continue to be wary of them. Ultra Electronics has dropped down to rank #11 with a still-hefty 8.3% short position, the other three being Pets at Home (#18, 6.4%), Plus500 (#20, 5.8%), and Marks & Spencer (#21, 5.6%).

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The 10 stocks I’m avoiding today The table below shows the current top shorted stocks and their share prices. The new entrants are John Wood, Babcock International, Thomas Cook, Greencore and NewRiver Reit.

Debt is certainly an issue with a number of the companies, including Thomas Cook, as I discussed in a recent article . Often though, short sellers’ theses aren’t disseminated for public consumption. Having said that, they do occasionally appear.

IQE was the subject of two research reports early last year, by short sellers ShadowFall and Muddy Waters, the latter describing the AIM-listed tech company as “an egregious accounting manipulator.” IQE published its responses to the reports on 5 and 8 February 2018.

Similarly, FTSE 250 engineering outsourcer Babcock International came under attack for “accounting tricks and obfuscations” in research reports by Boatman Capital last autumn (Babcock published a response on 12 November) and last month (Babcock’s response was on 15 May).

Published short-seller reports aside, I’m very happy to continue to err on the side of caution and simply blanket-avoid the top 10 shorted stocks. The way I see it is: why pit my wits against well-resourced and forensically-skilled short sellers when there are plenty of other stocks in the market?

G A Chester has no position in any of the shares 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.

Motley Fool UK 2019

First published on The Motley Fool