Most Shorted Stocks #3 – KIT Digital

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I recently read an article that outlined the most shorted stocks in the market, based on percentage of shares sold short. Stocks that are shorted always fascinate me, because without leverage, the total percent that can be gained is 100%. In the traditional long trade, there is no limit to how much you can make. I guess by nature I root for the underdog, so I wanted to see if any of the most shorted stocks might represent a buying opportunity. Stocks with a heavy short interest can be volatile, but if the shorts are wrong you can see big gains in a short (pun intended) amount of time. The company ranked #3 most shorted stock by percentage of shares, is KIT Digital (NASDAQOTH: KITDQ) with 39.2% short interest.

KIT Digital offers “end-to-end video asset management software and related services.” In plain english, KIT offers a way for video to be shown across, browser, mobile devices, and set top boxes. To start evaluating this company, let's see what the stock is currently valued at.

Current Price: $10.12
P/E on '12 earnings: 12.97
Growth expected: 20.83%
PEG: 0.62 

On the surface it looks like the stock is undervalued. If a company sells for two-thirds of its growth rate, you've either found a bargain, or a stock with a problem. Let's see which category KIT falls into. When it comes to earnings, KIT has struggled mightily. The company has missed earnings estimates in 3 of the last 4 quarters. KIT is not just missing estimates, they are missing badly. The company has an average miss in the last year of 173%! This makes figuring out KIT's future growth rate challenging to say the least. If analysts expect 20.83% growth, but the company misses estimates by over 100%, their real growth rate might be less than half of what analysts are expecting.

Sometimes earnings hide the real cash earning potential of a company. Unfortunately, KIT Digital is not one of those companies. KIT actually shows negative cash flow in all of the last 4 quarters. In order to meet expenses, KIT has also diluted existing shareholders by issuing stock in every quarter this last year.

The only positive that I can find about KIT Digital is they do show a net cash position on their balance sheet of about $48 million. The challenge of course is that without positive cash flow the balance sheet might suffer. The company will either need to continue issuing shares, or they will need to raise funds through debt offerings.

Honestly, I think the shorts are right when it comes to KIT Digital. My guess is their growth rate is probably more like 5% - 8%. Since they have been missing estimates by such a large margin, I can't have faith in analysts predictions of future growth. I'm placing a red thumbs-down on CAPSCall for KITD to back up my position.

This might sound strange, but if you are willing to take a risk on a company that is not as heavily shorted, I would look at Nokia (NYSE: NOK). Nokia is more than just a cell phone company, they are also a competitor of KIT. The stock is certainly a turnaround play. With the shares fetching just $5.30, and expected future growth coming in at 2.8%, it doesn't sound exciting on the surface. However, Nokia has improved its cash flow in each of the last 4 quarters. In addition, the rollout of Windows 8 will serve to help Nokia gain smartphone brand awareness. The company pays a dividend of about 3.4% while you wait, and they have plenty of cash ($14 billion in cash and investments) to wait for Windows 8. In the meantime, the company is busy producing multiple versions of smartphones using the existing Windows Phone software. Nokia doesn't need Windows to win the smartphone battle, they just need to come in third. Third place behind iOS and Android would be more than enough to get Nokia back to where they have been in the past. I realize this is a risky play as well, but Nokia has a plan, is cash flow positive, and pays a dividend. I can't say the same about KIT Digital at this point. Let me know what you think in the comments section below.


Motley Fool newsletter services recommend Nokia. The Motley Fool owns shares of KIT digital. MHenage has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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