On October 12, I wrote an article on seven bull stocks to know in healthcare (medical) sector. In the present article, I will be taking you through the seven stocks that you could profit by shorting.

Before we start, I warn you of potential risks in shorting.  The first and most important point is that short selling can be hugely risky and needs to be managed extremely carefully as a process – stop-losses need to be monitored, borrowing needs to be kept under control and anyone considering shorting has to thoroughly research their candidates. Shorting is not a business for inexperienced investors – many experienced professionals in the hedge-fund world frequently get their shorts badly wrong, losing hundreds of millions of dollars in the process.

Our stock universe

Our stock universe (after eliminating penny stocks) of healthcare stocks starts at 299 stocks. We will not consider stocks whose average trading volume is less than 50,000 (because if the volume is lower than 50,000 then I believe institutional players can easily change the game with a single or few trades).

There are several ways of discovering short stocks. The simplest but time consuming way is to look at the short interest for each stock. This method is not advisable for folks like us (retail investors who lack sophisticated databases and/or time to research). Next best way is to you look at valuations of selected stocks to see if their valuation is driven more by speculation rather than inherent strength or future growth drivers. High price to sales (P/S) ratio and high one year forward price to earnings (P/E) ratio generally indicate stocks that are profitable by shorting.

It was not possible to get one year forward price to earnings (P/E) ratio so I will screen the stocks based on current P/E and P/S. Then I will use short interest to select our final seven potential short stocks.

Manageable list

P/E values of our stock universe range from a low of 0.86 to 27876. P/S values range from 0.04 to 30190. A very high value for 1year forward P/E and P/S need not necessarily mean shorting possibilities as those values are not always driven by short term profit driven trading.

There were only 183 stocks that met penny stock criteria and average volume criteria. Further we can eliminate stocks whose P/E values are less than 12 (the reason being these stocks are assumed to be giving normal returns which means they don't present us opportunities to make profit by shorting). Further we can eliminate stocks whose P/S is also below 5. Now we are left with only 17 stocks.

            *Short Interest Ratio

Final seven

We will pick the final seven based on P/E and days to cover (or short interest ratio). A P/E below 30 and short interest ratio below 3 days may not give us sufficient time to buy the stock, so we eliminate them. Now we are left with only seven stocks namely Conceptus, Inc. (CPTS, last price 18.79, 52 week range 9.01 – 20), Masimo Corporation (MASI, 28.7, 21 – 32.98), NuVasive, Inc. (NUVA, 39.59, 24.17 – 49.95), Luminex Corporation (LMNX, 15.86, 12.57 – 24.92), Alexion Pharmaceuticals, Inc. (ALXN, 47.97, 28.16 – 48.93), BioMarin Pharmaceutical Inc. (BMRN, 17, 9.93 – 21.23), and Intuitive Surgical, Inc. (ISRG, 262.96, 84.86 – 269.27). These stocks are potential shorts for different reasons which can't be covered in this article.