Being right gets you only so far on Wall Street. Ask any short-seller. Shorts' dire predictions about the demise of the Internet bubble proved correct, as did their continual harping about accounting irregularities--long before such things became a media obsession. Yet short-selling remains a vaguely disreputable practice, and the only publicity most shorts usually get is when they are sued or--as in the celebrated case of Encinitas (Calif.)-based short-seller Amr Elgindy--when they are accused of some kind of chicanery. Elgindy recently pleaded not guilty to, among other things, bribing FBI agents for information to use in shorting microcap stocks such as waste-disposal company Nuclear Solutions (NSOL).
The Elgindy scandal is a shame because short-sellers perform a valuable service in debunking Wall Street hype. Though it is risky, short-selling can be a valuable tool for sophisticated investors who want to hedge and diversify their portfolios. Shorting involves selling borrowed shares in the hope of buying them back at a cheaper price. You can bet against the market as a whole by short-selling the shares of funds, traded on the American Stock Exchange, that replicate the Dow Jones industrial average, the Standard & Poor's 500-stock index, and other indexes. Professional shorts do trade such shares but prefer to aim at companies they view as weak or overvalued.
Pharmaceutical companies are a longtime short-seller favorite. One stock that could be a "shrieking sell" in that realm is Cephalon (CEPH), in the view of Steve Kirsch, senior managing director of Sterling Financial Investment Group, a boutique brokerage that concentrates on drug companies, mainly from the short-selling perspective. The West Chester (Pa.)-based Cephalon is a favorite with analysts, according to a recent ranking by First Call. But Kirsch is unimpressed by the prospects for the company's top-selling drug, Provigil, which is approved by the Food & Drug Administration for treatment of narcolepsy and is also widely prescribed for other uses, including depression and to alleviate sleepiness. Cephalon is trying to get FDA approval for labeling the drug for treatment of depression. Kirsch, however, does not believe the effort will succeed.
Similarly, Kirsch and other Sterling analysts--who sometimes short the stocks on their "sell" list--are underwhelmed with products in the pipeline at AstraZeneca (AZN), a British drugmaker whose American depositary receipts trade on the New York Stock Exchange. Among other things, the Sterling crew doesn't share analyst enthusiasm for the company's new cancer drug, Iressa, or its Crestor cholesterol drug. Kirsch believes the company's ADRs, now trading at about $40, could fall back to the $30-to-$32 range.
Equally bearish views of drug-launch prospects have also prompted Kirsch to issue sell recommendations on a bunch of other drug companies, large and small. They include the Nasdaq-traded Biogen (BGEN). Kirsch feels brokerage house analysts are being overly upbeat about Biogen's Amevive psoriasis drug. A Biogen spokeswoman says the company doesn't comment on analyst opinions.
Pharmaceuticals are also on the sell list of noted short-seller Manuel Asensio, known for his vociferous, sometimes litigation-producing research reports. Asensio is particularly sour on PolyMedica (PLMD), a Woburn, Mass., medical-supplies company. In April, its shares soared after it announced an unconventional bit of good news--that the Securities & Exchange Commission had ended a probe of its accounting practices and public disclosures without taking any action. But, according to the company, a Justice Dept. investigation continues. PolyMedica has strongly denied any wrongdoing, but Asensio believes that its risk profile is far too high, to say the least. He is shorting the company, now trading at about 26, in the belief its shares will plummet.
Asensio also "likes" (in the strictly negative sense) San Diego-based Qualcomm (QCOM), which sells wireless hardware and systems. Like the drug companies on Kirsch's sell list, Qualcomm is a favorite of analysts and recently was the subject of a flattering profile in Barron's. Asensio believes that the company, with its price-earnings ratio of 33, is grossly overvalued, even though its shares are down almost 40% so far this year. "It's one of the last remaining irrationally exuberant stocks in the market," he says. Asensio figures that Qualcomm, now trading at about $30, will fall to well below its 52-week low of $25.
Asensio is also shorting ParkerVision (PRKR). The Jacksonville (Fla.) company develops and markets microelectronic hardware and software for the communications industry. The company's most recent earnings release noted that its revenues climbed a handsome 52% in the first quarter. All the same, Asensio rates the company as a "weak player in a highly competitive market." ParkerVision has already declined sharply so far this year, but Asensio expects it will fall even more.
Price declines don't necessarily please the shorts, because some stocks that have suffered deep drops can draw bargain hunters, who can cause a rebound in the stocks--and losses for the shorts. They prefer high-flying stocks, which are comparatively more vulnerable but rare in this bear market.
One such company is Petco Animal Supplies (PETC), which is based in San Diego and operates animal-supply stores throughout the country. Petco shares have climbed handsomely so far this year, pushing its market capitalization to $1.4 billion. But one veteran trader, who requested anonymity, believes that the company's growth prospects are far from glowing.
Precious metals stocks are another happy hunting ground for shorts. One they are starting to circle is Silver Standard Resources (SSRI). At $6, it's just over the $5 level that most brokerage firms set as the minimum price for stocks they're prepared to lend to shorts. Vancouver-based Silver Standard has properties all over--Australia, Canada, Bolivia, Argentina, and the U.S. All promising, say SSR enthusiasts. Only one problem: "So far, they've never mined a single ounce of silver," says one short who requested anonymity. But an utter absence of revenues hasn't prevented this stock from gaining 120% in the year to date, as investors seek out precious metals stocks.
Of course, SSR may strike silver, PolyMedica may shake off its legal troubles, and so on. Best of luck to them. But if they happen to fail--well, at least some people will make money.
Corrections and Clarifications
Sterling Financial Investment Group analysts do not take short positions in stocks the firm recommends (``What to Bet Against,'' BusinessWeek Investor, July 1 in some editions).
By Gary Weiss