The list of Australia’s most shorted stock is dominates by basic materials and energy players. The list’s top four has more than 10% of their issued stock in short positions, indicating investor pessimism about the share’s future success.

What is shorting?

 “When someone shorts a stock, they’re trying to sell something that they don’t actually own because they think they can make money later by buying it back at a lower price,” says Morningstar director of investor education Karen Wallace. “Hedge funds do this a lot, but short-selling can be very complicated and risky for individual investors to attempt.”

Shorting is simply a way to profit from a stock falling. Say that you are ‘sure’ that a stock is going to drop in price. Instead of investing in a stock in the traditional sense, where you think the price will rise, you would short a stock. You do this by borrowing shares from brokers and selling them. The brokers themselves are lending them to you from other holders of the shares, so there is a fee associated with the right to do this. The fee that you pay goes to the broker and to the holder of the shares.

By taking possession of the shares and then selling them, you immediately receive cash. Say you borrow 100 shares of a company trading at $10. In this case, you would immediately get $1,000 minus any brokerage paid and the cost of borrowing the shares. Of course, you are borrowing these shares, so they must be returned in the future. If everything goes to plan, the share price would fall which would allow you to buy them back. If the share price fell to $5, you would buy the 100 shares back for $500. You would make a profit, since they were already sold for $1,000.

One really important part of this equation and shorting is the upside and downside possibilities for you as an investor. When you buy a share, your losses are limited to the stock going to a price of $0, but you’ve got unlimited potential – the stock can rise in price – exponentially. Shorting is the other way around, but your gains are limited. A stock can only go to zero, which means your return is capped at 100%. If a stock continues to climb, however, the more it is going to cost you to buy back the shares to return to the lender – so the downside with shorting is limitless.

Due to this, short positions need to be monitored very closely. You need to be able to cover the short by buying back the shares.

Other investors know that short sellers will be forced to cover – or buy back the shares – if the stock rises too much. The short sellers buying back the shares will make the stock price continue to rise as there are even more buyers in the market. This is called a short squeeze and has been a longstanding occurrence in stock markets around the world.

Short interest in stocks can be used to gauge market sentiment, but we encourage investors to focus more on the long-term value of the stock, rather than volatility. The short holding periods of these positions are indicative that this is an exercise in speculation instead of investing.

Below, we look at the most shorted stocks in Australia to gauge this market sentiment, and to consider what our analysts think about the future success of some of these companies.

Here are the most shorted stocks in Australia:

Australia's most shorted stocks

Figure: the most shorted stocks in Australia at the end of September 2024. Source: ASIC and Morningstar Direct

Below, we look at the top three most shorted stocks under Morningstar’s coverage. The poor performance that some investors have tried to speculate and profit from has pushed most of these stocks into undervalued territory.

IDP Education IEL ★★★★

IDP Education is a global leader in education services, providing English language testing and teaching, student placement services, digital marketing, and education events.

The English language testing business is IDP’s largest business segment, comprising 64% of fiscal 2022 revenue. Student placement services is IDP’s second-largest business segment, comprising 27% of fiscal 2022 revenue. Over the decade prior to the COVID-19 pandemic, IDP’s student placement services business has also been IDP’s main engine for growth, with growth primarily coming from India as a fast-growing source country and the United Kingdom and Canada as fast-growing destination countries.

Morningstar’s IDP analyst Shane Ponraj thinks IDP’s balance sheet is in sound condition. Financial risk is low given its current net cash position and IDP’s main businesses having below average exposure to economic cycles. He forecasts IDP to maintain its net cash position over the 10-year explicit forecast period, while also funding planned increases in capital expenditure on IT and maintaining a 70% dividend payout ratio.

Ponraj has assigned IDP a narrow moat due to network effects in its English language testing business. As part-owner of International English Language Testing System, or IELTS, IDP operates one of the world’s most widely accepted English language tests for access to education institutions, professional bodies, and visas. As IDP is granted more licensing rights as an English proficiency certifier, the IELTS certification itself becomes more valuable for its wider acceptance and thereby attracts additional prospective students, employees, and migrants. This incentivises additional education institutions, employers, and migration authorities to accept the IELTS certification to tap into large pools of prospective students, employees and migrants. Joseph Taylor has written about other ASX shares that benefit from network effects here.

Our analyst Shane believes that IDP has a fair value of $23 per share, but the shares still look undervalued at around $15.42 (at 8 October 2024).

He thinks that IDP can reap higher margins as the more profitable student placement business grows as a percentage of overall revenue. Ponraj gives IDP an Uncertainty rating of High. As a facilitator of migration, IDP faces risks from deglobalisation and government decisions to limit migration and places for foreign students. While IELTS is a valuable network asset, there is a risk that co-owners the British Council and Cambridge Assessment terminate key licensing agreements and impair the network effect.

Mineral Resources Group MIN ★★★★

Mineral Resources' mining services business builds, owns, and operates crushing and screening plants on behalf of mining customers. Mineral Resources grew significantly following listing on the Australian Securities Exchange in 2006. Demand for crushing and screening services grew strongly with iron ore output from the major Western Australian iron ore miners. Cost inflation encouraged large mining companies to outsource capital-intensive, lower-returning processes. Mineral Resources also rapidly expanded its own iron ore mining business, though lacking the integrated rail and port infrastructure of major competitors and at a competitive disadvantage. More recent diversification into lithium production at Mt Marion and the Wodgina mine delivered earnings momentum.

Commodity prices generally fell in the September-ending quarter, except for gold. Concerns about weak China end-user steel demand affected iron ore and other steelmaking commodities, while base metals prices fell on worries over slower economic growth in China and elsewhere.

Mineral Resources is the cheapest of our non-lithium-focused mining coverage. Lower near-term iron ore and lithium prices drive its 39% discount to fair value. But we expect earnings to rise as its lower-cost, long-life Onslow iron ore mine ramps and lithium prices recover.

Morningstar’s Fair Value for Mineral Resources Group is $60, with it currently trading at $53.34 (at 8 October 2024).

Karoon Energy KAR ★★★★

Karoon Energy, formerly Karoon Gas Australia, listed on the ASX in June 2004 and spent the first 15 years or so of life raising equity to direct to petroleum exploration, including in the Browse Basin offshore Western Australia and in the Santos basin offshore Brazil. The company raised over $850 million in new equity between 2004 and 2019, but the approximate $300 million market capitalisation in 2019 basically reflected simply the remaining net cash on balance sheet. No cash-generative assets had been delivered and no shareholder returns made.

Given the poor return on investment, the decision was ultimately taken to refocus efforts on more value-adding production or development assets, while still leveraging existing in-house capabilities. To that end, Karoon bought 100% interest in the Bauna oil field from Brazil's state-controlled Petrobras in November 2020 for USD 665 million.

Given the radically favorable turnaround in oil prices, the Bauna acquisition has proven timely indeed. 

Karoon also continues to actively screen additional potential acquisition opportunities with a focus on oil assets located in Brazil and the Americas. A second asset would diversify risk, amortize corporate costs over more than one project, and expand production opportunities. The company will pursue both organic development, and inorganic oil acquisition opportunities.

We think Karoon lacks a sustainable competitive advantage, or a moat. It is essentially a one asset company and the cost of future resources, either through exploration or acquisition, is too uncertain to award a moat despite near-term high returns on invested capital (ROICs). The company produces oil from its wholly owned offshore Bauna field in Brazil’s Santos basin.

Karoon is currently trading at a 38% discount to its $2.65 Fair Value (at 8 October 2024).

What should you do?

Speculation can be intellectually stimulating—not to mention exciting—but it is however fraught with danger, Morningstar behavioural researcher Sarah Newcomb notes.

“Put simply, a group of investors got organized and found a few companies whose price they could manipulate if they acted en masse to create a microbubble, if you will. Playing the game of price arbitrage is, in this context, both legal and fun, but it is also based largely on speculation about human behaviour, not underlying value.

“Wise investors will see it for what it is: a temporary price adjustment based on nonfundamental factors. Speculation is fun. It's why a lot of people love investing, and if you speculate with only money you can afford to lose, events like these can be exciting and sometimes profitable. Still, if you are new to investing, don't understand the difference between fundamental value and market price, or you are considering putting money on the line that you need for your present or future security: stop, breathe, and walk away.” she says.

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