Ideas Farm: Seeing good in a bad situation

A few weeks ago this column touched on the subject of how quant-maestro Jim O’Shaughnessy had demonstrated that monitoring company quality can improve investor returns when it is used as a “negative” screen. An interesting thing about this approach is that quality is more usually used as a “positive” screening tool; identifying high-quality stocks that may be worth buying. However, Mr O’Shaughnessy found that by simply avoiding shares in low-quality companies, the performance of an index could be significantly improved. 

In a similar but opposite vein, we’re introducing a new feature to the Ideas Farm this week which may help readers use what is generally considered a negative indicator - short interest - in a positive way. When investors short shares they bet against the price. Shares are borrowed from their owner and then sold in the market. The hope of the shorter is that when the shares have to be returned to the owner, they will be available to buy at a lower price than they were originally sold at. Research suggests that high short interest can be a good indicator that a share price will fall. However, there have also been findings that suggest low short interest can be a positive indicator.

The new tables we’ve introduced to the Ideas Farm this week highlight the biggest movements in short interest based on Financial Conduct Authority (FCA) disclosures. Essentially, while sharp rises in short interest play to the familiar negative theme, falling short interest may suggest positive developments at a company, which have caused short sellers to close out their positions in anticipation of share price rises. 

Nothing in investment is black or white. Frequently short interest will unwind when bad news has caused a share price decline only to build up again with expectations that the next big tranche of  bad news is on the way. Cineworld (CINE), which has once again reclaimed its position as most shorted share in our main shorts table is a case in point. So, as with all the tables in our Ideas Farm, the new data giving details of the top five weekly movements - up and down - in short interest are there to help generate ideas as opposed to being blindly followed. 

In our tips section this week we’ve included the case for a share where we believe falling short interest should be seen in a positive light. The shares are those of home improvement retailer Kingfisher (KGF). Over recent weeks and months, the company has also featured in our lists of shares making new 52 week highs and companies experiencing strong broker forecast upgrades - both of which can be powerful momentum indicators.

The changing consumer habits caused by lockdown appear to be turbo-charging Kingfisher’s recently instigated turnaround plans. The fact that short interest was so high until not very long ago does highlight that the good news story is yet to be firmly established. That said, if the turnaround is a success, it could mean many years of improving profitability and growth - two things that have been absent for the company for most of the last decade. So even when Covid is just an unpleasant memory (fingers crossed), the benefits of the current trading tailwind for Kingfisher may still be playing out.

Our other tip this week also draws inspiration from the Ideas Farm tables and is also another beneficiary - in trading terms - from the pandemic. Thermo Fisher (US:TMO) is one of the most held stocks among the biotech and pharma fund managers whose portfolios we monitor, and whose “best ideas” we publish this week. Business is booming for Thermo Fisher because of the vital role its kit and services are playing to combat the virus. Also in common with Kingfisher's investment case, the benefits from the pandemic will not necessarily prove fleeting. The investment the company has been making to expand its operations and deal with increased demand should give it capacity that can be profitably utilised in more normal times, too.