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Global equity investors seem to have regained their appetite for risk but no one knows how the rest of the year will pan out – and which stocks will implode. Reporting season is a dangerous time because “earnings misses” can be punished with extreme share price falls.
2022’s volatile markets present opportunities for those looking to take advantage of changes in valuations, whether they are companies trading cheaply such as certain European banks, or those looking expensive like oil and defence companies.
The Financial Conduct Authority (FCA) produces a daily list of the most shorted stocks. It gives an insight into what professional investors think about particular sectors, and sometimes gives an early warning sign of a company in trouble. That could be helpful to retail investors if they’re looking to sell out of an underperforming stock.
Usually there are a mix of factors at work: sentiment is against certain sectors like retail because of fears over inflation and recession, professionals have seen something they don’t like in the accounts (that others haven’t spotted), or shorters are following the momentum of a weak stock. And there have been a fair few weak stocks this year.
Last time we looked at this list, in June 2022, cinema operator Cineworld (CINE) was top of the list, followed by online fashion firms Boohoo (BOO) and ASOS (ASC).
Two months later, retailer Kingfisher (KGF) has moved into the top slot with more than 9% of its stock being shorted. Boohoo and ASOS remain in number two and three slots, while Cineworld moves down to number four. Shares in B&Q owner Kingfisher are off around 27% so far this year, and Morningstar analyst Matthew Donen thinks the shares are undervalued at around 250p, with a fair value of 353p.
Sticking with the undervalued theme, Morningstar also covers ASOS, whose shares are off nearly 55% so far this year. Analyst Jelena Sokolova recently lowered her fair value estimate for ASOS to £41.10 after the June profit warning, saying the former AIM darling was caught up in a “perfect storm”. The firm has blamed its slashed profit and revenue outlook on increased customer returns, higher prices and shipment costs, as well as the fallout from its suspended Russian operations. Sokolova still sees value in the stock, which at more than £30 below its fair value, is significantly undervalued according to Morningstar metrics.
On top of economic pressure, regulators are also looking closely at the sector. Online fashion firms Boohoo and ASOS are currently being investigated by the UK’s Competition and Markets Authority over whether they are making misleading claims about sustainability.
Two asset managers have crept into the top 10 and they are emerging markets specialist Ashmore (ASHM) and abdrn (ABDN), both of which have seen share price falls this year. (We have profiled the travails of emerging markets in our recent special report.)
Looking at our top 10 list, Naked Wines (WINE) is the biggest faller this year with a loss of 76%. The online booze retailer has recently parted company with its chief financial officer and has warned of weaker sales in the future. Its shares promptly dipped.
Short selling can be a highly profitable way to exploit the falling share price of companies in distress. It involves selling shares you don’t own to make a profit from the fall in the price.
To do this, you borrow them from specialist firms like brokers, sell them at the current market price with the hope of buying them back at a cheaper price later. This active trading strategy is usually only undertaken by professional investors, but often provides an early warning sign of problems ahead that can be picked up on by all.
Firms that have attracted short sellers in the past include Thomas Cook and Carillion in the UK, and the scandal-hit Wirecard in Germany. Shorting tends to attract other shorters, however, and some argue it only hastens the demise of a company.
To an outsider, short sellers may seem like shadowy figures in the investment industry. But alongside specialist trading firms and hedge funds, some of the biggest asset managers are involved in shorting, including BlackRock, Jupiter and JP Morgan.
Often short positions can be taken out to cover “long” positions as part of everyday risk management, where fund managers are managing their significant stakes in companies. Other familiar names on the FCA’s list include Marshall Wace, Citadel Advisors and GLG Partners.
Last year, the regulator changed the rules for declaring short positions, effectively lowering the bar for transparency. Investors now need to notify the FCA when their position in a company exceeds 0.1% of its issued share capital (previously the threshold was 0.2%). Short sellers must also notify the FCA every day about who they are shorting and the size of the short position.
The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person’s sole basis for making an investment decision. Please contact your financial professional before making an investment decision.
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James Gard is senior editor for Morningstar.co.uk
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