A Shorting Shopping List

 | Jan 05, 2012 | 12:45 PM EST
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Before I move on to running my regular value screens and kicking over rocks in corners of the market, I want to take a look at some of the stocks you should avoid and more aggressive investors might want to consider shorting.

This year, all but the most conservative of investors should have a little bit of their portfolio directed to shorts. If you adopt my chicken short approach, using puts and put spreads, you can gain decent exposure to potential falling-rock stocks without committing an enormous amount of capital.

I know that there are always global political and economic risks in the world. When I started investing we were still fighting the cold war and there have been many geopolitical and economic crises over the last couple of decades. The market usually manages to overcome them. Right now the global risks seem higher and larger than any time in the recent past and they could derail the stock market. Supplying liquidity in Europe has provided a short-term fix, but we will still see market-moving events form the Old World. The Middle East is a powder keg that could drive stocks much lower than they are now. The US economic recovery is still struggling to escape the L-shape it has maintained since 2009.

By focusing on stocks that are overvalued on fundamentals, I increase my chances of winning my short bets even if the market holds up OK. I reverse the criteria I use for stocks too cheap not to own and look for stocks that are too expensive to own no matter how great the business looks. When I have run the screens for the past few years, Amazon (AMZN) has always been at or near the top of my list of overpriced stocks. I have always been reluctant to short the stock as it is a great company and I am a frequent user of their service. But it made a huge bet on the e-Reader and tablet markets and that is getting to be a crowded space fast. The stock just about broke even last year with a 2% gain and any bad or weaker-than-expected news could send this stock tumbling from its lofty heights. The shares trade at almost 90x earnings and more than 50x free cash flow. I just do not see how any company can grow fast enough to justify those multiples.

I have written several times in the recent past about my long-term bullish stance on real estate. But one of my higher-conviction shorts going into the year has to be Simon Property Group (SPG). While other shopping center and mall operators trade near book value, have single-digit cash-flow multiples and are seeing insider buying, Simon trades at a stunning 8x book value, 64x cash flow and insiders are selling large amounts of stock. The company owns a strong portfolio of properties, but it has the same issues all other retail-oriented real estate operators are facing with a weak economy and online shopping digging into profit and ultimately rental rates and occupancy levels.

The REIT yields less than 3%, so there is just no real reason to own the stock. Institutions own 95% of the shares and Simon share should see a strong wave of selling as the large funds reallocate towards cheaper properties in 2012.

My final pick for today is going to be a stock I have battled to a standstill so far. I totally get that Lululemon (LULU) athletic and yoga apparel is trendy and very popular with higher-income consumers right now. I understand they do not have a lot of stores and can expand their locations. I get the Goldman loves the stock right now. I also get that at more than 40x earnings and 26x cash flow all this is priced in. What does not appear to be priced in is that you can work out and do yoga in sweat pants from Wal-Mart as easily as in a $250 outfit from Lululemon. I also understand that insiders are selling stock with both hands. Institutions own pretty much all of the stock, so it will be a crowded exit if the company should stumble and miss the lofty expectations of the always-highly-accurate Wall Street analysts.

I will have a few ore picks on the short side tomorrow. If I can interrupt Bob Byrne's deep meditative attempt to think snow into existence and shake Tim Collins away from his in-depth study of options pricing and beer labels, I will add their technical and option expertise to help set up short sales of overvalued stocks for 2012.

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