Carillion plc isn't the only stock I'll be avoiding in 2018
While there are plenty of stocks I want to buy 2018, there are also several I'll be steering clear of. Here's a look at some of them.
As far as dud investments go, it doesn't get much better than Carillion(LSE: CLLN) this year. Shares in the construction services company have fallen from around 240p at the start of the year, to just 17p today. That's a decline of a staggering 93%. What went wrong?
It all went downhill in July when the company released a nasty profit warning. It stated that a deterioration in cash flows on a number of construction contracts had led the board to undertake a review of the group's material contracts. That review resulted in expected contract provisions of £845m.
But it got worse. A further profit warning in November revealed that profits for the year are expected to be "materially lower" than current market expectations. The company also said that it was expecting a covenant breach as at 31 December and that "some form of recapitalisation" would be required.
What a nightmare. I feel for investors who have lost money here. A 93% loss is extremely hard to recover from. To break even, you'd need a gain of a huge 975%.
Yet, there were warning signs here. A large proportion of the company's shares were being shorted. I explained that in this article.
The lesson we can take away is that it's always worth keeping an eye on the list of companies that are most shorted. Hedge funds and other sophisticated investors are betting on the share prices of these companies falling. And there's usually a good reason why.
If a company has a seriously heavy short interest, just steer clear. It's as simple as that. At one stage, 30% of Carillion's shares were being shorted. This indicates that there was something drastically wrong with the company. And the shorters were right.
Looking at the short interest now, Carillion is still the most shorted stock in the UK, with 13 funds shorting it.
For this reason, I won't be investing in Carillion any time soon.
Other shorted stocks to avoid
So what are the other most shorted stocks in the UK right now? From Shorttracker here's the top 10 most shorted stocks.
Source: Shorttracker. Data as of 20/12.
You can see that there's a strong focus on the UK high street there, with companies such as Debenhams, WM Morrison Supermarkets and Marks & Spencer Group all making the list.
One stock that looks particularly dangerous to me is Ocado. While the company has exciting growth prospects, the valuation just looks way too high, in my opinion. Expected earnings of 1.56p next year place the stock on a forward P/E of 230. That's a recipe for disaster. As a result, the chances are I won't be buying Ocado shares next year.
For higher returns, avoid these mistakes
Cutting out large losses can make a big difference to your overall investing returns over time. After all, if a stock falls 50%, you need to make 100% to break even.
With that in mind, if you're serious about generating stronger stock market returns, I'd urge you to read the report The Worst Mistakes Investors Make.
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Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.