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Enron: Could your stock be next?
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November 30, 2001: 6:04 p.m. ET
We turned to three short-sellers for the stocks that are scaring them most.
By Paul R. La Monica
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NEW YORK (CNN/Money) - Everybody loved Enron. It was in the S&P 500. It was the seventh largest firm on the Fortune 500. Highly regarded investors like Abby Joseph Cohen recommended it as a leader in its field. And every quarter it turned in solid earnings growth ahead of expectations. This wasn't some dot-com with no hope of ever making money.
Well, it turned out that there was plenty to be concerned with on Enron's balance sheet and many analysts failed to recognize that. And this week, the jig was finally up -- and the stock, at 28 cents, has lost almost all its value. It only goes to show that even the bluest of blue chip stocks can be a ticking time bomb.
To try to find other well-known companies that could have unpleasant surprises waiting for investors, we sought out some short-sellers, investors who bet on a stock's decline. Although shorts are often derided for their negative views, they should get a little credit for making the right call on Enron.
Short interest, the total number of shares being held short, in Enron (ENE: down $0.10 to $0.26, Research, Estimates) ballooned from 13.8 million shares in mid-September to 31.1 million shares as of November 15. "Investors should absolutely look at short interest because short sellers do better homework than buyers of stock. That's for sure," says Mark Roberts, director of research for Off Wall Street, a Cambridge, Mass.-based research firm that specializes in making sell recommendations.
Staying away from GE and Big Blue
Here's one simple rule shorts abide by: if you can't understand the company's financials, then you probably shouldn't buy the stock. "Watch out for managements that ask investors to take a lot on faith without providing a lot of detail," says Roberts.
William Fleckenstein, president of Fleckenstein Capital, a money-management firm in Seattle that engages in short selling, says that General Electric is a company that fits this description. Although Fleckenstein is not shorting GE (GE: down $1.23 to $38.50, Research, Estimates), he says that investors would be wise to stay away from the stock because of all its moving parts -- a mish-mash of different businesses in several countries reporting in a variety of currencies. "It's literally impossible to know what's going on there," he says.
In response to this criticism, General Electric spokesman David Frail says, "GE is no more difficult to understand than AOL Time Warner (the parent of CNN/Money.com) or any other multi-business company."
IBM is another company that Fleckenstein is wary of, although he is not predicting anything near the likes of Enron's epic collapse. "IBM is not going to come unstuck like Enron did but if this recession is as ugly as I expect it to be, IBM will be in a world of hurt," Fleckenstein says.
His main concern is that IBM (IBM: up $1.16 to $115.59, Research, Estimates) has been able to make earnings look better than they actually were over the last few years because income from its pension fund has been booked as after-tax gains. In addition, he calls IBM's balance sheet "scary". Big Blue had $10.9 billion in short-term debt as of September 30 and $17.7 billion in long-term debt. Fleckenstein is shorting IBM. (IBM did not return calls seeking comment.)
Looking past pro-forma
Companies that report so-called pro-forma earnings -- which often exclude one-time charges associated with mergers, asset writedowns, joint ventures and discontinued businesses -- are also targets of short sellers. Manuel Asensio, founder and president of short selling firm Asensio & Co., says Qualcomm is a stock that he is short-selling for this reason.
In its latest quarterly report, the wireless technology company reported a pro-forma profit of 20 cents a share -- at least that's the first number the company chose to publicize in its press release. But if you dig deeper, you'd find that Qualcomm (QCOM: up $0.30 to $58.72, Research, Estimates) actually lost 6 cents a share, or $44 million.
A big reason for the disparity is that the pro forma numbers did not include the writedown of assets associated with Globalstar, a bankrupt satellite phone firm that Qualcomm invested in. Due to these and other charges, Qualcomm lost 73 cents a share in fiscal 2001, a big difference from the pro-forma profit of 98 cents a share that was more prominently noted in the earnings report.
"All they have are losses," notes Asensio.
But Qualcomm vice president and treasurer Dick Grannis says that Qualcomm isn't misleading investors. "We bend over backwards to provide all the details about pro forma and reported earnings so that investors can have a full understanding of the results," he says.
David Tice, who runs the Prudent Bear mutual fund, suggests that investors steer clear of Dynegy, in the news recently because of the planned acquisition of Enron that it backed out of on Wednesday. (Tice is also shorting Qualcomm.)
Tice says he's worried about some of Dynegy's continued exposure to Enron. Dynegy (DYN: down $3.30 to $30.35, Research, Estimates) owns $1.5 billion in preferred stock of Northern Natural Gas, a pipeline company owned by Enron, and there is concern about what will happen to Northern Natural Gas if Enron, as widely expected, files for bankruptcy.
Shorts aren't perfect
Now investors need to take the words of short sellers with a grain of salt -- just as they should be somewhat dismissive of overly bullish sell-side analysts. After all, short sellers profit from a stock's fall -- so the more bearish news about a stock they are shorting, the better. And individuals should probably avoid the risky practice altogether.
But if nothing else, the skepticism provided by short sellers is a healthy balance to the almost ceaseless positive spin emanating from major Wall Street research brokerage houses. 
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