Another way to find attractive stocks

A strategy that could produce good results in the medium/long term is to buy great stocks that are heavily shorted after a bad quarter or some bad news.

What does "stocks heavily shorted" means? It refers to stocks that are sold before being bought. In other words, some people sell stocks today thinking that they'll be able to buy them at a lower price in the future.

I've never done any short selling. I'm not comfortable at all with that approach. But even if you're not comfortable with it, short selling could serve you to identify stocks for which there's an exaggerated pessimism.

When a company is hated, it may also be shorted. What about Valeant, the most hated stock in the recent history of capitalism? I'd thought it was impossible but Valeant seems more hated today than it was 3 months ago. But strangely, Valeant is not that shorted. For a stock supposed to go to zero, there's not so much people thinking that they could do a homerun by selling Valeant at 88$ today and buying it at zero in a couple of days.

High number of short sellers happened in the recent past with Home Capital Group and CGI Group (remember the Obamacare fiasco?). Both were and still are great companies. But even great companies face some difficulties or simply face a short seller with lots of exposure.

A couple of years later, all seems forgotten for CGI for which the PE ratio has expanded a lot. Human is a forgiving creature.

So, here's an interesting way to chose stocks from a list of heavily shorted stocks:

1- Type "shorted stocks" on google (for a specific stock, go to www.morningstar.com, type the name of the stock and watch the percentage of the float which is short)
2- Look for familiar companies on the list;
3- Take a look at the ROE of the familiar stock for the last 5 years (on www.reuters.com);
4- Take a look at EPS growth for the last 5 years (on reuters too);
5- Read recent news to understand why the stock is so heavily shorted. If it's related to a single event or a single analyst that benefits from lots of exposure, the situation is probably not that critical. Perhaps you should even buy that hated stock. 

Which known stocks are shorted these days? (source: morningstar, which is not the most accurate website in my opinion, but it's better than nothing). The percentage of the float which is short is indicated besides the name of the stock.

1- Mylan (13,2%)
2- Mattel (13,4%)
3- Fastenal (16,2%)
4- W.W. Grainger (17%)
5- Carmax (19%)
6- David's tea (19,4%)
7- Lululemon (21,8%)
8- Portfolio recovery and associates (23,3%)
9- Tesla (28,6%)
10- Chesapeake Energy (45,8%)

Usually, when stocks are shorted, it's for a reason. Most of shorted stocks are not appealing. Most are crappy stocks. But sometimes, there's a Home Capital Group or a CGI in the list. In the list above, there's Mylan, Fastenal, Mattel, Carmax and Grainger. I wouldn't bet against them. I'm not a specialist of these stocks (although I've owned some shares of Grainger in the past) but they all look pretty solid companies in my view. I'd rather bet against a shitty company that never achieved some consistency in it's results. If you ever bet against something, bet against crap.

And if you're like me, check for gems that are mistaken for crap. It doesn't happen so often, but it happens enough to keep an eye open.