Is there hidden value in shorted companies? – 3 share ideas

Short Selling, also known as ‘shorting’ or ‘going short’, is a strategy aimed at benefiting from falling stock market prices.

So, when the stock price falls, a short seller will make money. But this means the opposite’s also true – short sellers lose money when the price of the stock rises.

It’s a very risky strategy because, theoretically, share prices can rise to unlimited levels, meaning a short seller’s losses can also be unlimited.

Why should investors be aware of short positions?

When a company has a large short position against them, it could be a sign that there’s a serious issue at the company. This could be for a variety of reasons like too much debt, the business being in a tough spot in the market cycle, or if there’s an ongoing company scandal.

But in some cases, even though there’s a short position against the company, there might still be an investment case.

Short positions can push the company’s valuation down. But if the shorted company can weather whatever storm attracted the short sellers, there’s potential for a revaluation upwards.

Here’s a look at some large companies with a high percentage of their stock currently sold short.

This article isn’t personal advice. If you’re not sure an investment is right for you, seek advice. Investments and any income from them will rise and fall in value, so you could get back less than you invest. Past performance isn’t a guide to the future. Ratios also shouldn’t be looked at on their own.

Investing in an individual company isn’t right for everyone because if that company fails, you could lose your whole investment. If you cannot afford this, investing in a single company might not be right for you. You should make sure you understand the companies you’re investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.

Remember, before you can trade US shares, you need to complete and return a W-8BEN form.

GEO Group

GEO Group specialises in designing and running detention facilities, with 102 sites across the US, Australia, South Africa and the UK. The group also gives post-release support which includes community re-entry programmes and electronic monitoring systems.

These services helped the group bring in revenue of $1.2bn over the first half of the year.

Running prisons provides a certain level of security for revenue. Prisoners need to be housed somewhere, and the buyers of GEO’s services are typically governments with deep pockets.

The group’s electronic monitoring systems have been a beacon of light recently. Use cases and adoption of this tech have been increasing, with revenue growth in this area particularly impressing us.

Cash flows are solid too given that governments are legally required to pay on time, typically within 45-60 days. With average contract lengths in the seven-to-ten-year range, GEO has good revenue visibility in the near term.

The problem at GEO lies in the balance sheet. The group’s carrying a hefty chunk of debt, and it’s paying the price for it. Interest payments on this debt have shot up year-on-year, taking some of the shine off an otherwise good financial performance.

The higher interest payments are coming from the fact GEO’s recent refinancing of this debt has pushed the due date further into the future. But the current high interest rate environment has made servicing the debt more costly in the meantime. That’s the main reason we saw net profit fall over a third in the first half.

Reducing this debt pile has been called out by management as the key priority, and there’s been some positive movement already. Executing this goal will be crucial to improving investor sentiment, and any potential revaluation higher.

See the latest GEO Group share price and how to deal

Occidental Petroleum

Occidental Petroleum (Oxy) is a large oil and gas producer, with its operations spread across the US, Middle East and North Africa. Its primary focus is exploring for and producing oil and natural gas, which helped bring in $14bn of revenue in the first half of 2023.

Back in 2019, Oxy loaded up on debt as part of its $57bn acquisition of Anadarko Petroleum. Part of this deal was financed by Warren Buffett’s Berkshire Hathaway, which got an equity stake in Oxy in return. Since then, Berkshire has upped its stake and now owns around a quarter of the company.

The Anadarko deal left Oxy with a lot of debt at a bad time – right before the pandemic sent oil prices spiralling downwards. This made it difficult to repay debts and the dividend was slashed to free up cash. To steady the ship, the group was forced to cut back spending, sell assets and streamline processes.

Fortunately, oil prices have since recovered. Coupled with strong margins, which are among the best in its peer group, Oxy has been able to significantly reduce its debt to more sustainable levels. And shareholders are now benefiting from share buybacks and a growing dividend. Remember, dividends are variable, and no shareholder returns are ever guaranteed.

Dividends vs share buybacks – what investors need to know

Strong free cash flows and operating income of $3.7bn in the first half are part of the reason why Oxy’s currently trading at a high valuation relative to its peers.

The Oxy Low Carbon Ventures (OLCV) is another potential avenue for growth, with plans to build between 70 and 135 carbon capture facilities and sell the associated CO2 tax credits – potentially boosting the bottom line from a ‘greener’ angle.

But ultimately, Oxy’s fortunes are closely tied to the price it gets for its products, particularly oil, which is determined by forces outside of the group’s control. The economic outlook and potential recessionary fears remain a threat to demand.

The author holds shares in Occidental Petroleum.

See the latest Occidental Petroleum share price and how to deal

Papa John’s International

Papa John’s has been filling stomachs with slices of tasty pizza since 1984, and has since expanded its operations to 48 countries. Revenue of $1bn rang through the tills in the first half, down 2.2% on last year.

That brings us to the likely factor for the short position on this pizza provider. Restaurants are at the mercy of the industry’s cyclical nature. And with broader economic conditions being unfavourable at the moment, that’s leaving consumers with less cash to spend on eating out.

And it’s not just consumers that have been wrestling with these challenges. Businesses around the globe have had to adapt as input costs have risen at double-digit rates.

Soaring energy prices have also been a real thorn in the side, increasing the cost of firing up the ovens. All of this has weighed on Papa John’s underlying operating profit, which fell 11.2% to $76mn in the first half.

To make matters worse, margins are already at the lower end relative to peers, making Papa John’s more exposed to a downturn. That means managing costs is going to be especially vital in the near term.

Elsewhere in the business, we’ve been impressed by Papa John’s ability to leverage technology effectively. Its loyalty member base swelled from 14m to 28m members between 2019 and 2022, now accounting for more than half the group’s US sales.

It’s created a pool of sticky customers who are more likely to order again, which should help smooth some effects of the industry cycle.

Papa John’s quick-service model and efficiencies from operating at a large scale have the potential to make it a relative winner in this environment, scooping up market share in the process.

The valuation’s come down a long way, reflecting the near-term challenges. We can’t rule out further turbulence from here, but this presents a long-term opportunity to gain exposure to the restaurant industry at a more reasonable valuation.

And with the group eyeing expansion in vast markets like China and India, there’s potential for Papa John’s to grab a bigger slice of the global pizza market – although there are no guarantees.

See the latest Papa John's share price and how to deal

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

Share insight: our weekly email

Sign up to receive weekly shares content from HL.