How low will it go?, page-57

SHORTING DISTORTIONS

The recent contrasting sharemarket performances of Dick Smith Holdings and the Reject Shop raise questions about the role of shorting and its influence on market valuations.
During the course of this year as short interest in the Reject Shop has fallen from 10 per cent of the issued capital to less than one per cent, the stock has risen strongly.
Most of the increase in the share price has occurred in the past three months.
Market consensus is that the Reject shop will earn about $18 million in the year ahead which means it is trading on a forward price earnings multiple of about 19 according to Bloomberg.
Contrast that with Dick Smith which has seen the short interest rise consistently through the year to hit 13 per cent of the issued capital on October 21, according to ASIC data.
As the shorting interest has risen the stock has slumped. But there has been no change in the market consensus for Dick Smith to earn $45 million in the year ahead.
Dick Smith is now trading on a forward price earnings multiple of 6.6 according to Bloomberg.
The bottom line is that the Reject Shop is valued at $322 million while Dick Smith is worth $300 million and yet Reject Shop is expected to earn 60 per cent less.
Do the shorters know something that the rest of the market does not? The answer to that question may be known on Wednesday when Dick Smith holds its annual general meeting.
If the company issues a profit downgrade it will provide confirmation the shorters got it right. If it confirms the market consensus it will simply highlight the disconnect between stock prices and earnings.