There Can Be Only One

 | Jun 07, 2012 | 4:00 PM EDT  | Comments
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Stock quotes in this article:

enph

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pbi

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nflx

It appears that my instinct to do nothing over the past few months has been correct. Although the world was scheduled to end at the end of last week, it did not happen. Central banks around the globe made just the right announcements and struck just the right tone to reassure equity investors. As a result, we have rallied nicely. China cut rates this morning, and that had everyone excited in the early hours.

A lucky few may have gotten the swings correct over the past few weeks, but in the main, I suspect that a lot of money has been lost by trying to guess the stock market's recent gyrations. Staying the course has exposed us to some volatility, but we are pretty much even at this point. I like what I own and see no compelling reason to buy aggressively.

I never stop kicking over rocks in search of cheap stocks. One idea that I have utilized with success in the past is an attempt to profit from the battle between insiders and short sellers. This stock screen produces results that are probably more interesting to my more trading-oriented friends, but it has found some explosive stocks in the past and may do so again.

The screen is pretty simple: Look for stocks that have recent insider buying as well as a growing short interest ratio. Both groups have a strong opinion on the company's prospects and are willing to back it with cash, but, as we have learned in the past and from Highlander, "There can be only one." The screen also unearths some very interesting potential trading situations.

Enphase Energy (ENPH), which makes microinverters for the solar sector, has seen its short ratio increase by more than 50% over the past few months, and its shares have fallen right along with the rest of the industry. Revenue is climbing quickly, but the company is still losing money. As the stock rose earlier this year, the short sellers chipped away at it.

At least one member on the board of directors has been buying stock as the price declines. The fact that the board member is Daniel Loeb of Third Point Partners leads me to suspect that North American demand for Enphase's products will continue to strengthen and that the shares may recover sharply.

Short sellers have been increasing their positions in mail facilitator Pitney Bowes (PBI) all year. It is easy to see why. The company is in danger of becoming a buggy-whip business, as the United States Postal Service continues to fall out of favor as a preferred shipper vs. its competitors. Standard & Poor's recently cut Pitney Bowes' credit rating a notch on concerns about secular trends and a weak economy.

The stock has fallen sharply this year and is now below the 2009 lows. The dividend yield of over 10% appears enticing, but it will likely be cut soon. So far, the short sellers are wining by knockout, but since the selloff in May, insiders have begun to bet on a turnaround. The CEO and CFO have recently made sizable additions to their stakes in the company, and historically, that is very bullish.

Netflix (NFLX) also makes the cut, but this one is a stock that I love to hate. I hate the service. I hate the valuations. I hate all the alleged value managers who claim that the shock is cheap at a mere 30x earnings.

A lot of folks agree with me, because the stock has more than 20% of the float sold short, and that has been ticking up since early April. Starting at the end of April, however, at least two directors of the company began making substantial open market purchases of the stock.

Someone will win the battle between insiders and short sellers. Investors and traders who join the battle can also earn explosive profits if they choose the right side.

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