Blog - Investing Notes
November
1, 2004 – Are Short Sellers Smarter Than the Average Bear?
Should investors avoid stock with a high short interest?
In their March 2004 paper entitled "Short Interest and Stock Returns", Paul
Asquith, Parag A. Pathak and Jay R. Ritter examine short selling trends
and test the performance of stocks with high levels of short interest.
Using data covering the period 7/88-12/02 for NYSE-AMEX-NASDAQ firms
and 2/76-12/02 for NYSE-AMEX firms only, they find that:
- Short interest as a percentage of total market
capitalization has grown steadily over this period.
- Equally weighted portfolios of stocks with high short
interest ratios reliably underperform the market; value (market
capitalization) weighted portfolios do not.
- The more heavily shorted are the firms in a portfolio,
the more negative is its performance.
- Heavily shorted stocks tend to be small (but not micro)
capitalization growth companies. In fact, the only class of stocks that
reliably produce negative abnormal returns is that of small firms with
extremely high short interest ratios.
- The underperformance of high short interest firms is
fairly brief, and rapid portfolio turnover is therefore necessary to
capture it.
- Shorting based on valuation concerns (rather than
convertible bond arbitrage) drives the underperformance of high short
interest firms.
- The underperformance of high short interest NYSE-AMEX
stocks is more severe and consistent than that of similar NASDAQ stocks.
In summary, investors should avoid stocks with high
short interest ratios. If you already own a stock that develops
sustained high short interest, sell it immediately. You can
gamble on squeezes, but on average you won’t win.
For related research, see
Blog Synthesis: Short Selling and Short Interest.
