In my book, Taking Charge With Value Investing (McGraw-Hill, 2013), I discuss unmeasured fundamentals to explain how investors can use these things to make better investment decisions and to capitalize on overly pessimistic behavior. One topic is identifying the difference between a justly short stock and one that is not. For example, stocks such as UniPixel Inc (NASDAQ:UNXL) and Universal Display Corporation (NASDAQ:PANL) are appropriately shorted, as most reasonable investors understand that it is simply a domino effect that is leading to such large gains. However, in the case of stocks such as Pandora Media Inc (NYSE:P) or even Navistar International Corp (NYSE:NAV), investors’ pessimistic long-term outlooks can often be beneficial and create large gains when a catalyst presents itself.
To better explain, I’ll conclude with Spectrum Pharmaceuticals, Inc. (NASDAQ:SPPI):This is a company that has seen multiple years of growth, has three FDA approved products, 10 drugs in its pipeline, a P/E ratio of 8, yet still has a short ratio of 33.30. The presence of shorts will keep the stock volatile (100% more volatile than the market), and will keep it from appropriately appreciating to reflect fundamental performance. But as we’ve seen in the past, eventually the overly pessimistic outlooks will create large and sudden gains. The key is patience, being able to remain calm and logical despite frustration, and you will then reap the benefits when being short backfires.
Brian Nichols is long SPPI. The Motley Fool recommends Universal Display Corporation (NASDAQ:PANL). The Motley Fool owns shares of Universal Display Corporation (NASDAQ:PANL).