A lot of investors hate the notion of short selling. Especially when someone’s shorting the hell out of one of their stocks!
Of course nobody likes to see their shares trashed just so that someone else can make a ‘well-earned’ profit.
But you know, a short attack isn’t always bad news. In fact, it can provide you with a fantastic opportunity to buy a quality stock and make a good profit.
That’s a point I made back in May when clothing retailer Supergroup (SGP) had been hammered all the way down to £3 from over £18 at the start of 2011.
Today we’ll look at how you could have made a mint by going toe to toe with the short sellers. It’s not just the fact that you can get an extremely good in-price as they hammer your stock down. The shorters are highly exposed – at some point they have to buy back in. And that leaves them at the mercy of a short squeeze.
When that happens, it can lead to a rapid price rise as the shorters scramble to buy back shares to close their positions and stop losing money.
I want to show you how the short squeeze hammered Supergroup’s short-sellers yesterday. Supergroup rocketed back up over £5.80 as the shorts were slain.
Let’s take a look at what’s been happening.
Why Supergroup’s shorters were wrong, but got lucky
Frankly, I can see very well why many folk would think Supergroup is a fly-by-night fad – and worthy of a short. Many saw it expanding too quickly – there was even talk of the hubris behind the decision to open a grand Regent Street mega-store. And with hindsight, even I now see that management turned out to be ill-prepared.
But the reason I argued the shorts were wrong in this case is simple: this business has no debt. Personally, I wouldn’t short anything without a debt problem.
Debt is what takes down individuals, companies, or even governments. If there’s no debt, then the business is quite likely to keep plodding on. And seeing as it costs you money to short (whereas you generally earn money on a long), then what’s the event that’s going to drive the shares down?
Now, clearly the guys that were early to short this stock made a killing – well done them. But to be honest, I think those guys were just lucky. They shorted because they believed the brand would fall out of fashion. But in reality, the shares tanked for totally unrelated reasons... a series of management blunders.
Anyway, here’s the chart – you’ll see that the initial short brigade did okay...
Supergroup six-month price chart
But it wasn’t until later in the summer that the shorts really got into gear. It wasn’t until June and July that Supergroup earned the accolade of the most shorted stock in town. And that was exactly when the stock hit rock bottom!
The early bird caught the worm. But as the trade got ‘hot’ all the way through the summer, all the shorters were really doing was holding the price down for anyone that wanted to get in cheap. That was why I suggested topping up on SGP.
As I say, I’ve got no problem with anyone that cares to short a stock with a chart looking this bad. But in this case it was a mistake.
An exclusive report from The Right Side
Yesterday the shorts got squeezed – badly!
Now, the thing with a short position is that you’ll always have to buy back in... unless the business goes bust – something that’s unlikely to happen to a business without debt!
Most shorters will operate a tight stop loss. That is, if the trade moves against them, they’ll close it out – otherwise they’re open to unlimited losses. Now that leaves the shorts highly vulnerable to what’s known as a short squeeze, where the stop-losses get triggered and lock in losses.
It all started at 7am. That’s when Supergroup released its quarterly interim management statement (IMS). Basically, this is a trading update that tells investors what they can expect when the full details are released later in the year.
It was mostly good news. But nothing earth-shattering. Like-for-like sales growth came in at just under 2% – not great, but in this environment, OK. Overall, sales (when you include new store openings) were up nearly 20%. With a company in the early stages of the growth cycle (which, in my opinion, Supergroup is) we’d expect that.
After all, Supergroup is investing in a lot of new stores, so turnover should be growing at the 20% level. Supergroup also advised that, having opened 13 new stores across the globe during the last quarter, its international expansion is going well. They announced a deal with a franchise operator who’ll open stores across the Middle East and North Africa.
And with a solid trading report like this, the stock went up 20p straight off the bat. But then the fun and games started.
I suspect a lot of short traders started to run for the exits. Many must have realised their mistake. Supergroup is still growing! And what’s more, international expansion could put a rocket under the shares over the coming months and years.
And as short traders buy back stock, it creates even more demand – the price goes up – moving against anyone still short. Come late afternoon, the pips began to squeak. The shorts got clobbered, the squeeze was on as the price moved as high as £5.80 – 45p or 8% up on the day.
Shorting stocks is all well and good – providing you choose your stock carefully. Always have in mind a trigger that you believe will pull the stock down. Remember, it costs money to short – it’s not wise to have an open-ended short. Especially if it’s against a growing business with a healthy balance sheet.
I still believe Supergroup shares are cheap. I share many concerns about the fragility of the brand. But whenever I start to worry, I just look at the books. Despite some management errors last year, Supergroup keeps on growing. Despite the fact that it’s not my cup of tea, the brand is strong.
What’s more, there are some really exciting opportunities for global expansion – especially into the emerging markets of India and North Africa.
I’m sticking with Supergroup. This could be quite a ride!
• This article is taken from the free investment email The Right side. Sign up to The Right Side here.
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