KBH earnings spike

KBH is up 16.4% after it announced a profitable quarter.  A quick glance at the press release shows that the profitable quarter is entirely due to an income tax benefit.  Operationally, the business has higher revenues and lower losses.  Looking at the revenues for the 2012 quarter versus 2011, revenues were $424M compared to $367M.  Total pretax loss was -$7.439M versus -$9.649M.

The spike is likely due to covering by short sellers as KBH has a massive short interest.  Some short sellers will cover their position as it moves against them.  Bronte Capital has a client letter which describes their short covering on China Medical.  They will also short stocks where a squeeze is likely occurring to take advantage of those temporary market dislocations (in other words, when it happens to other people).  Jim Cramer describes in his book Confessions of a Street Addict how there is a cabal of Wall Streeters who make a sport out of squeezing hedge funds with too much short exposure to a particular stock… he used to be the victim and then he became the victimizer.  The Jim Cramers of the world probably figure out other hedge fund’s short positions because the brokers have loose lips and let rumours slip.  Cramer and company’s tactics only really works on hedge funds which have 10% or so of their portfolio shorting a single stock.  A position of that size pretty much kills their short-term performance, triggering redemptions and forcing them to cover the short position to meet redemptions.  It will not work on Bronte Capital as they have less than 1% of the portfolio shorting any single stock.  I mention these things only to shed some light on the dynamics that may be going on.  Behind the scenes, there are games going on between short sellers and crafty traders who squeeze them.  I have no idea if some poor hedge fund was overexposed to KBH.

In conclusion, I don’t believe that this earnings spike has anything to do with fundamentals.  This is likely a reasonable entry point for a short position in KBH.  You can take a tiny short position, weather the storm (because the squeeze can get ridiculous) and wait until the supply/demand fundamentals balance themselves out.

*Disclaimer:  Be careful with short selling.  As mentioned in previous posts, there are several ways one can lose money on shorting stocks that eventually go down.  Clearly some short sellers are losing money in KBH as they are covering portions of their positions at a loss.

*Disclosure:  I am currently short KBH and China Medical.  I don’t disclose very small positions in my portfolio updates since some of the positions are very small and sometimes I will take very small positions without doing much research on it.  When I saw the VIC writeup on China Medical that mentioned the bond default, I went short a position of 200 shares (Interactive Broker’s commissions are cheaper for 200 shares than 100 shares).

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