It’s a thin line between love and hate, and that applies to investing as well. Sometimes the most hated stocks can offer the best opportunities, if you’re brave enough to buy them. These two stocks are the most shorted in the UK, the ones investors fear are most likely to flop. Dare you defy the herd?
1. Metro Bank
FTSE 250-listed Metro Bank (LSE: MTRO) has been in the headlines for all the wrong reasons. It’s now the most shorted stock on the UK index, according to fund manager Fidelity, with a whopping 12.49% of its shares shorted.
The high street challenger bank was only founded in 2010, but 2019 has been its annus horribilis, with the Metro share price losing three quarters of its value since January. That happened when it announced a £350m share placing to patch up an accounting error. Sorry, to finance future growth.
Metro stock has fallen after it admitted mis-pricing £1bn of commercial and buy-to-let loans, leaving itself short of capital. My concern is that when problems emerge in banks (and others) they tend to run deeper than originally thought.
That said, the Bank of England’s Prudential Regulation Authority recently said Metro is “profitable and continues to have adequate capital and liquidity to serve its current customer base” and earnings forecasts seem positive, with City analysts forecasting 51% growth next year.
If you think you can match that, then now would be a good time to buy. However, given its problems, I expected a cheaper forecast valuation of 21.4 times earnings. I still find Metro difficult to love. I’m not sure management has learned its lessons yet.
2. Arrow Global Group
So why have investors got it in for European credit specialist Arrow Global Group (LSE: ARW)? It is almost as heavily shorted as Metro, with 10.91% betting against it.
Arrow buys up debt from banks, credit card companies and telecoms businesses, then tries to make money from collecting it. This model reaped rewards after the financial crisis when distressed debt was dirt cheap. But margins have been shrinking as the group reduces its risk profile by purchasing fewer, better quality debt portfolios.
CEO Lee Rochford painted a bullish picture last month, saying Arrow is a “highly cash-generative business” and the debt pricing environment should improve. Free cashflow grew 32% to £57.8m, while core collections increased 22.7% to £105.5m. Underlying profit before tax increased 14.1% to £16.2m, further improving the picture.
In contrast to Metro, the Arrow share price chart has been pointing upwards lately, rising 11% in the last three months. Combine that with a rock-bottom valuation of 5.3 times forward earnings and Arrow stock starts to look tempting. Especially since earnings are forecast to rise 6% this year and an impressive 16% next. There is a massive dividend too, with the current forecast yielding 6.9%, and cover of 2.7.
Arrow seems to hit the target but I’m worried the hedge funds shorting its shares know something I don’t, especially with brokers Berenberg warning of a lack of accounting transparency. Tempting at this price, but assess all the dangers first.
