Warning! I think these 10 stocks could destroy your wealth in 2019

G A Chester reveals one way canny investors can avoid potentially wealth-destroying stocks in the coming year.

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One of legendary investor Warren Buffett’s most famous pieces of advice is: “Rule No. 1: Never lose money. Rule No. 2: Don’t forget rule No. 1.”

Now, like all of us, Buffett has lost money on some stocks. The secret is to try and keep your losers to a minimum, particularly those that produce a permanent loss of capital. Here’s one way that’s enabled me to avoid a number of 100% wipeout stocks over the years.

Long and short of it

As investors, we look to own a share of a business that grows its sales and profits, with the result that we enjoy increasing cash dividends and a rising value of the shares we own. However, it’s also possible, by ‘shorting’ stocks, to profit from the value of a company’s shares falling.

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Shorting, or short-selling, is when an investor borrows, and immediately sells, shares at the prevailing price. If the price falls, the short-seller can buy the shares back at the lower price, return them to the lender and pocket the difference. Shorting is far riskier than owning shares (having a ‘long’ position). If a stock goes to zero, the short-seller makes 100% profit, but shares can rise by many multiples of 100%. In theory, the loss for a short-seller who gets it wrong is infinite.

Early warning system

Any institution with a short position of 0.5% or above in a UK-listed stock (and any individual with a position of 0.2% or above) must disclose it to the Financial Conduct Authority (FCA). The FCA publishes a daily spreadsheet of publicly disclosed short positions.

Now, because shorting stocks is so risky, those who engage in it — typically sophisticated hedge funds and astute individuals — are incentivised to dig far more deeply into a company’s business model, accounts, personnel, and so on, than the average long investor. As such, a high level of short positions in a stock can be an early warning of a company with serious issues. Taking note of the level of short interest can enable long investors to dodge bullets.

The table below shows the 10 stocks with the highest short interest at the start of 2018, their share prices at the time and today, and the gain or loss on the shares.

  Short position at start of 2018 (%) Share price at start of 2018 (p) Share price today (p) Gain/(loss) (%)
Carillion 16.4 17 0 (100)
Ocado 14.3 397 770 94
Debenhams 14.3 35 3.9 (89)
Premier Oil 12.0 76 57 (25)
Morrisons 11.9 220 220 0
Telit 11.2 150 127 (15)
Sainsbury’s 11.0 241 270 12
Marks & Spencer 11.0 315 250 (21)
Provident Financial 10.7 657 589 (10)
Aggreko 10.4 799 715 (11)

As you can see, short sellers don’t always get it right, with Ocado being a notable fail. However, I’d be happy to miss out on the odd Ocado, for the benefit of avoiding a complete capital wipeout (like Carillion) or near-wipeout (like Debenhams).

Looking ahead

So, which stocks are on my ‘avoid’ list today? You’ll find them in the table below, which details the 10 companies currently sporting the highest short interest.

  Short position today (%) Share price today (p)
Arrow Global 12.1 176
Kier 11.6 396
Marks & Spencer 11.6 250
Ultra Electronics 10.7 1,272
Plus500 10.5 1,284
Debenhams 10.3 3.9
Pets At Home 8.9 116
Anglo American 8.6 1,752
IQE 8.2 65
AA 8.1 67

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Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

G A Chester has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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