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  1. Home
  2. / Investing
  3. / Basic Materials

Move Against the Short-Term Crowd

Look for cheap stocks that have insider buying and a high percentage of the float sold short.
By TIM MELVIN May 27, 2014 | 03:00 PM EDT
Stocks quotes in this article: SFY, HERO, CDE

One of the many discussions around Chez Melvin this weekend was the question of buying the popular stocks rather than the unpopular stocks. After all, the exciting stocks generate all the news and headlines, and they can make quick moves on the basis of news and media hype.

To a trader, that may sound like perfection, but it doesn't do much for me. Every piece of academic research I have ever read and almost 30 years of experience have taught me that eventually, almost all of the so-called popular stocks will eventually collapse, taking investors' money with them. This resembles the old game of "pass the burning match," and that's not really a game I want to play with my money.

I was asked how I would search for stocks if I wanted to invest or trade with a shorter time frame and still avoid the popular stocks of the day. My thoughts immediately go to the advice of Sir John Templeton: If you do exactly what everyone else is doing, you will get the same results. Since most traders fail, it seems unlikely to me that anyone would want to get the same results as everyone else by chasing the hot stocks and technical breakouts of one sort of another.

I am always shocked when traders' buy-lists do not include stocks that are seeing strong insider buying and sell lists fail to include those that have seen selling. You have stocks that have a historical propensity to move in the desired direction, and it makes sense to use that fact in order to select trading candidates. Also, value stocks tend to outperform, so it pays to look for those that are cheap on a book-value basis. I would then look for those stocks that have a high short interest, since any good news at all would create a short squeeze, providing me with a rapid price gain. I have traced stocks with high short interest and insider buying over the years, and insiders usually win that particular fight.

Out of curiosity, I ran a screen that looked for cheap stocks that had both insider buying and a high percentage of the float sold short. There are some very interesting names on the list, which closely resembles my personal buy list at the moment. While my time frame is a lot longer than those of most traders, it is gratifying to see that some of my holdings have the types of setups that should favor a shorter-term move higher in price.

Swift Energy (SFY) is one of my favorite long-term holdings in the energy sector. The stock has dropped like a rock for the past year or so and is currently trading at less than 50% of book value. Any positive news, such as a sale of its Louisiana holdings, could cause the shorts to cover the 37% of the float that they have sold. Insiders, including CEO Terry Swift, have been steady buyers of the stock in the past few months, and I would be willing to bet they have a better sense of the plans and prospects of the company than the sellers do.

Hercules Offshore (HERO) is another energy stock that is seeing shorts and insiders battle over its future stock price. The stock is cheap enough, trading at just 85% of book value, that there may not be much downside left. Eleven percent of the float is short right now, so any positive developments could give the stock a short-term life. For the long term, the stock has huge upside when we see an upswing in drilling activity.

Shorts have had a field day in the mining stocks the past year, as precious-metals prices have fallen steadily. I have no idea when we will see a rally in the metals, but when we do, the folks who are short more than 23% of the float in Coeur Mining (CDE) will be scrambling to cover their positions. Insiders were steady buyers of the stock in late 2013 at higher prices, and I am pretty confident that their bullish stance will eventually be validated.

Doing the same thing everyone else does is going to get the same results everyone else is getting. Whenever I talk to traders, they are all tracking the same setups on the same stocks. Given that something like 90% of all short-term traders are unprofitable, I cannot imagine that the average result is a desirable outcome. Perhaps a change in the thought process and selection methodologies is in order.

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At the time of publication, Melvin was long SFY, HERO and CDE.

TAGS: Investing | U.S. Equity | Basic Materials | Energy

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