06/17/96 THIS STRATEGY MAY COME UP SHORT

THIS STRATEGY MAY COME UP SHORT
Partly because of hype on the Internet, short-selling is more hazardous than ever
Their names--and price-earnings ratios--are becoming legendary: Comparator Systems, Iomega, Planet Hollywood, Presstek, Netscape, America Online, and countless others. Many action-oriented investors have eagerly followed these sometimes apoplectic issues into the stratosphere while other investors, though enticed, are just too scared to get involved. But there is a third option: Some of these hot stocks may well be attractive candidates for short-selling. Some of them, indeed, have already fallen back to earth.
But be warned: The short game is changing. Hyping of stocks on the Internet is keeping some stocks soaring longer and higher than used to be the case. And the relentless upswing of the stock market is making all short-selling hazardous. The best short bets, increasingly, are companies with serious but little-publicized problems. While they don't display the high price-earnings ratios that are the usual tip-off of overvalued stocks, investors can profit from the likelihood that they will remain locked in a slow but inexorable decline.
SIMPLE? On the surface, at least, the case for short-selling is grounded in simple math. According to Short on Value, a newsletter that tracks overpriced stocks, more than 20% of all stocks now trade at p-e ratios of more than 30--as compared with 5.5% at the end of 1988. Yet nowadays, the newsletter noted, 6% of all companies have operating losses--vs. 2% in 1988.
A good example of the market's tendency to overvalue companies can be found in the sudden rise and fall of Comparator Systems Corp. The Irvine (Calif.) company makes fingerprint-identification systems but has realized scant revenues for years. On May 6, the company issued a press release heralding the introduction of a new identity-verification system--and the stock went through the roof, abetted by hype circulated over Internet newsgroups and online services. The company's NASDAQ-traded stock climbed from 1/32 on Apr. 30 to 1 on May 6 in hysterical trading--177 million shares changed hands on May 7. But the stock swiftly fell to 9/16 on May 8, when trading was halted by the NASD. On May 31, the Securities & Exchange Commission charged that the company had misstated its assets. Comparator execs have denied the charges.
But the downside of short-selling can be enormous. As the bull market propels upward the shares of even the shakiest companies, unwary investors can easily be caught in troublesome short ``squeezes.'' When stocks rise, shorts must either give their brokers additional collateral or cover their short sales by buying the stock. Shorts traditionally have believed that even after the most severe squeeze the stock will come back down to earth relatively soon. But now it's taking a lot longer.
Some heavily shorted issues--Presstek Inc., for example--have continued to climb despite sky-high valuations. More and more investors these days are betting that the companies are legitimate--just a tad slow to make a buck. ``In some cases the technology is there, but it may take five years to realize it. It's hard to say if this is an area to stay out of,'' says Donald H. Newman, who follows tech stocks for Ladenburg Thalmann & Co.
Another hazard is the Internet and the online services, where hypsters shamelessly promote their investments. A particularly influential forum is the Motley Fool investment feature on America Online. Hyping on the Motley Fool model portfolio and message boards was a reason for the run-up in Iomega Corp., which makes computer memory-storage devices (BW--May 27). The company's earnings and revenues have rebounded in recent months, but its shares have soared more than fivefold so far this year. The company now trades at a p-e of 91, a whopping 70 times book value. Iomega has a market cap of $5.2 billion--dwarfing even the much larger disk-drive maker Seagate Technology Inc.--observes Ben Kopin, a veteran short-seller who heads Chicago-based Lynx Partners.
Although he doubts its valuation, Kopin is not joining the growing army of investors who are shorting the stock. Even though bears make a convincing case that Iomega stock should be avoided--that its price has gone far beyond its intrinsic value--Kopin feels that the online stock-pushing campaign makes Iomega a questionable short-selling candidate.
UNKNOWNS. With bucking the Internet-driven stocks so hazardous, the best bets for short-selling may be a different breed entirely--less widely known stocks that appear to be in an almost relentless eclipse. They are kind of a reverse of the well-known ``momentum plays,'' where stocks are driven higher on waves of investor enthusiasm. One short who asked for anonymity is shorting the shares of three laggard plays in the same field--manufacturers of equipment used in making integrated circuits. Lam Research, Micron Technology, and Novellus Systems are in high tech but otherwise are poles apart from the high-flying tech stocks that have been driving the market this year.
On their face, these stocks would even seem intriguing to buyers from a value perspective. All have fallen at least 10% in the year to date and are trading at sub-par p-e ratios--just 8 for Lam, for example. Shorts are betting in increasing numbers, however, that the shares of all three companies will be pummeled further by declining semiconductor prices. If so, these companies will continue to lose followers on Wall Street, driving down their prices. The short positions of these stocks have grown in recent months--but not enough to make them vulnerable to a short squeeze.
Savvy shorts are also rooting out companies with severe woes that are not generally recognized by the Street. Kopin puts Bay Networks Inc., a computer networking company, in that category. The company's shares have fallen 29% this year. A bad quarterly earnings report, however, encouraged value-hunters. A.G. Edwards & Sons Inc., noting the price weakness, recently issued a ``buy'' rating on the stock. But Kopin is shorting the stock in the view that its earnings will continue to come under competitive pressures.
He may well be right. But when even far less worthy stocks are moving skyward, shorts are learning one of the painful lessons of the stock market nowadays--you can be right about a stock and still lose your shirt.
By Gary Weiss in New York