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

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.

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.

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.