|How to Learn From NutriSystem's Short Position|
By Phil Erlanger JAN 15, 2008 3:00 PM
Remember that any shares owned in NTRI that are in a marginable account are open to be borrowed and then shorted.
Late last week Minyan David asked a great series of questions about NutriSystem (NTRI) and its shares short as a percentage of float. I hope to answer his questions in full.
David noted that from his data source that 63% of the available shares are short (shares short as a percentage of float). He was skeptical that this number was so high. Moreover, he wondered how long this condition can last and if rules had been put in place to eliminate naked short selling. Last, he was wondering what the thought process would be for entering on the long side. It is ironic that he asked that question but my firm is long the idea in our Consumer Tech Portfolio that we produce for our institutional client base. I know this stock well and the issues surrounding shares short as a percentage of float.
I'll break his question down into several pieces. First, I am not a fan of looking at the shares short as a percentage of float. Why? Simply the numbers are not reliable. This summer my firm received a call from The Baltimore Sun, which was doing an article on Under Armour (UA) and the high short interest in the stock. The newspaper reporter gave a shares short as a percentage of float number and asked if my firm could verify the number. We could not. Our number was different from the reporter's. My firm then reached out to Bloomberg, FactSet and Thomson and each data vendor had a different number. Back we went to Under Armour and the company could not produce a number. A day later UA called and gave us a number but told us it would be changing very soon.
Why would a shares short as a percentage of float number change? Simply because A) the company is buying back shares; B) it is issuing more share or C) insiders are selling their stock. The shares short as a percentage of float number will usually be in the ball park but it is rarely accurate. Company's do not have an incentive to keep this number accurate on a day to day basis. Yet, it is interesting that hedge fund managers would routinely quote a figure that is rarely accurate.
Meanwhile, the short ratio is an accurate number. It is the shares short as reported to either NYSE, AMEX or NASDAQ divided by average volume. My firm uses a 12 month volume average while the exchanges use a 20 day volume average. Once the short ratio is determined then we divide the shares short into the short ratio. In the case of NTRI, the short ratio is 12.55. My firm then plots the range of the short ratio to determine its short intensity over the past five years. In this case, NTRI has a short intensity of 100%. It is typical to see that whatever the shares short as a % of float is high if the short ratio and intensity levels are greater than 5.00 with a short intensity greater than 70%. Such is the case with NTRI.
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My firm's shares short as a percentage of float for NTRI is 66.87% which validates our comments above that there is not one absolute shares short as a percentage of float number available. David's number was 63%. His number comes from NASDAQ. Bloomberg reports a 73% figure. Again no one has numbers that agree!
David noted that he was skeptical of this high a figure given recent changes to naked short selling. Remember that any shares owned in NTRI that are in a marginable account are open to be borrowed and then shorted. Therefore, if very few holders held shares in a cash account, the float number could very high.
Reg SHO eliminates stocks from being shorted where a high percentage of the short position has not been delivered, due usually to no borrow being matched to short trade when it occured. Simply stocks on the Reg SHO List cannot be shorted. NTRI is not on this list and if fact a borrow is very easy. Although Reg SHO is supposed to eliminate naked short selling and now there are serious fines it still does exist. Unfortunately, naked short selling can often times take a stock lower. It seems enforcement of naked short selling still is not a priority of the SEC and good companies as well as bad get taken down by naked short sellers.
The length of time that short positions remain heavy in a stock can go on for years. Witness Overstock (OSTK). NTRI has seen its short position remain heavy since late September. We like to review how shorts have done when the short intensity gets excessive. Shorts have had their head handed to them in NTRI three times since it has come public and they have been correct twice.
The thought process behind going long the stock is pretty simple. The shorts overstay their welcome and the company becomes a value play with fundamentals that warrant a large price move to the upside. Value buyers like a Bill Miller or Mason Hawkins then bid up the shares as they perceive vale and the shorts decide to cover. My firm works with Ativo Research that does great cash flow analysis. Their valuation rankings are useful with a situation like NTRI. Ativo values NTRI at $53.35. Therefore, with the stock down from $75 NTRI appears to be a value buy and would be a reason to be a buyer of the stock.