Surging market brings short sellers out to ply their dark trade

Selling short. It's legal and can be quite profitable. In fact, with the market near a record high, this may be an opportune time to short. A short sale occurs when an investor borrows stock, sells it, and buys it back at a lower price (see article, page 27). To many investors, short selling connotes dastardly deeds. ``It's hard to get over the feeling that you are going against the United States, motherhood, and apple pie,'' says Michael Steinhardt of Steinhardt & Partners.

Then there's the swirl of ethical questions. Some professional short sellers actively spread their negative opinions about a company. Some admit to being part of a small group that shares information. This smacks of stock manipulation, critics charge. They also contend that bad-mouthing a firm undercuts sales, sours relations with creditors, and is a blatant self-serving, self-fulfilling prophecy.

But just as self-serving, counters Michael Murphy of the Overpriced Stock Service, is the ``massive infrastructure devoted to pushing prices up: investment bankers, brokerage firms, investor relations, corporate press conferences, newsletters. There's only a small and relatively weak network to push stocks down.'' Murphy says his San Francisco-based service is ``one of the few balancing sources of negative information.''

Other shorters say they're countering misperceptions and excessive speculation. ``If I think a stock is selling at two to three times its intrinsic value, I'll tell anybody I want about it. That's what makes this a free market of ideas,'' argues an active shorter who requests anonymity.

With the market at its current heights (the Dow Jones industrial average closed at 1,898.34 last Friday, up 10.54 for the week), short sellers, not surprisingly, are bearish.

``I've been waiting for this rally to do some shorting in more household names,'' says Murphy, citing Coca-Cola and Budweiser as two examples. Stocks generally are ``grossly overpriced,'' comments Steinhardt. ``Not since the spring of '83 have I seen this many fabulous short ideas come across my desk,'' enthuses another short player.

Arthur Bechhoeffer, editor of Independent Investors Forum of Penn Yan, N. Y., an on-line computer advisory service, says he shorts only occasionally.

But with the market where it now is, he says, ``I'm thinking very seriously about shorting. Unless profits pick up, this market is going sideways or down.''

Professional shorters look for cockeyed accounting practices, seek low-yielding issues, and often use computers to locate companies with price-to-earnings, price-to-book-value, and price-to-sale ratios that are higher than industry norms.

Continuous selling of shares owned by insiders -- corporate officers and directors -- over several months is another key indicator. Mr. Bechhoeffer says insider selling led him to successfully short Humana, ITT, USX, and Walmart last year. Bechhoefer ruefully notes that two current and as yet unprofitable shorts, Texaco and Kodak (both have potentially costly legal judgments pending), had no pattern of insider sales.

Ideally, a short player jumps in when stock prices are near where the insiders sold. But insiders are often slow in telling the Securities and Exchange Commission about trades.

Murphy occasionally steals a march by getting tips from disgruntled workers. He got a call from an employee at Insituform East, a small over-the-counter firm, who said there was substantial insider selling going on.

Murphy shorted Insituform in July at $25. Last week, the company reported financial problems, and its stock price, as of late last week, was down to around $15 per share.

Another fertile field for short sales is the initial public offering market. ``They're reliable underperformers; three quarters dip below their offering price within a year of going public,'' says Murphy.

Short sellers say hype often precedes a public offering. ``Managers do everything they can to make earnings look good. . . . Six months, a year later the glow is off and they have to produce results,'' says one fund manager.

Murphy is shorting the high-flying Home Shopping Network, which went public this spring at $18 and now trades around $129 per share. He thinks HSN will be undercut this fall when more competitors go public. But so far, he's lost money on his short position.

Short sellers also look for stocks pumped up by fads. Steinhardt says biotechnology stocks can be ``crazily overpriced'' because they tend to have little or no earnings. But Murphy won't touch biotechs: ``You never know when one of these guys will make a breakthrough or get written up in the New England Medical Journal.''

Murphy also stays clear of over-the-counter stocks with a single marketmaker which may have a vested interest in propping up an issue. Bechhoeffer doesn't like to short stocks comprising a futures or options index, due to wild fluctuations these can experience.