Buyers Beware: Two Large Caps With Growing Short Interest

By Soroush Pour - August 30, 2012 | Tickers: FB, LNKD, MCD, SONC, YUM | 0 Comments

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In the wide world of investment analysis, there are dozens of methods that can be used to determine the attractiveness of a particular stock. Indicators like trading volume, price volatility, and valuation metrics are some of the most popular (read here for more info); though we’re here to tell you that short selling activity should be on your radar as well.  In layman’s terms, a stock’s short interest measures the number of shares currently held by short sellers. An increased amount of short selling signifies that the bears are surrounding a stock, so to speak.

While this type of activity should not always send a cut-and-dry “sell” signal to investors, it should at least give them reason to pause. It should be remembered, however, that exceptionally high levels of short selling activity can trigger a short-term price appreciation in a situation known as a “short squeeze,” though betting on these types of events is a risky venture.  Below are two large caps that have seen their short interest rise in recent weeks.

Facebook (NASDAQ: FB)

As the blogosphere has already covered extensively, Facebook has been in a free-fall since its IPO in May, losing nearly half of its original value.  While the bulls are clamoring that a price below $20 a share may be a good buying point for a company with such potential, these claims are baseless.  Until Zuckerberg and Co. can figure out mobile advertising, or at least prove that other ventures like e-gambling and social gifting are profitable, there is no reason for negative market sentiment to reverse.  In the meantime, social media crazed investors would be wiser to consider LinkedIn (NYSE: LNKD), which has a much more balanced revenue diversification (30% advertising, 35% premium subscriptions, 35% job listings) than Facebook (85% advertising).

Now, in the short selling realm, the number of shares held by bearish investors has nearly tripled since the company went public.  Currently, Facebook’s short interest has amassed 87.9 million shares, up 55.0% from one month earlier.  Riding an equally augmented level of volume, FB’s “days to cover ratio” is above 2.0.  In most cases, however, a DTC ratio above 8.0 is a necessary requirement for a short squeeze scenario.  At its current market price, Facebook is still trading at a significant premium from both a Price-to-Earnings (125.0X) and a Price-to-Sales (11.1X) standpoint.  Moreover, the company trades at a PEG ratio of 1.5, signaling that there is no value play here, even when projected growth is factored into the equation.

McDonald’s Corp (NYSE: MCD)

This company is coming off a rare earnings disappointment, in which the fast food giant reported a second quarter EPS of $1.32, down 3 cents from last year’s Q2 results.  McDonald’s brass blamed the miss on non-U.S. sales, both in the emerging markets and Europe.  Regarding the latter, sales grew by just 3.8% after flirting with 6.0% growth at the same time last year.  Perhaps more troubling, though, is emerging markets sales, which remained nearly flat after growing by more than 5.0% in Q2 of 2011.  Now, the company is still on target to reach the Street’s year-end earnings estimates, which average $5.41 a share, up 2.7% from the $5.27 it reported in 2011.  Interestingly, this forecasted growth is actually below eatery competitors like Yum Brands (NYSE: YUM) at 13.1%, and Sonic Corp (NASDAQ: SONC) at 11.2%.

Combined with the fact that shares of MCD currently trade at a Price-to-Book that is 18.5% higher than historical norms, a bearish case can be made for the stock.  This may explain why Mickey D’s short interest has jumped 14.2% since the start of summer, and 40.5% over the past six months. WealthLift’s Sentiment Index still rates MCD as a moderate buy, though this situation is definitely worth monitoring. WealthLift INSIDER can keep you updated.

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