On High Short Interest Ratios

Two of my 35 stocks have short interest ratios over 10 days. [Short interest ratio = amount of shares shorted / average daily volume.] I look at this statistic, and force myself to re-examine companies where the ratio is over 10. Maybe there is something that I don't know.

The two stocks in question are Stancorp Financial (SFG) and National Western Life Insurance (NWLI). The short cases for both are based on a naive view of how insurance companies work.

Stancorp is a disability insurer. Disability insurers often do badly in a recession because disability claims increase - people who are unemployed claim they are disabled.

There are two models for disability insurance: 1) Underwrite carefully, and pay all legitimate claims. 2) Accept all business, but when claims come in litigate with vigor.

Stancorp follows the first model. I would never own an insurer that followed the second model, it is dishonest, and it is bad business. Because Stancorp does its risk management up front, it does not get the same degree of unemployment masquerading as disability claims. But the shorts don't get this. Thus the short interest ratio near 20.

Doesn't bother me. This is a undervalued company with a quality management team. Low debt. Sustainable competitive advantages in its niches. One nice thing about being a knowledgeable insurance investor is that you can get a firm grip on the nature of the management teams, and invest in the good ones when they are out of favor.

With National Western, the short interest ratio is near 11. Admittedly, it is an unusual company. No analysts. Large controlling shareholder. Hasn't lost money in over 10 years. Trades at less than 40% of adjusted book value. Sells insurance policies to foreigners who want flight capital.

With interest rates falling, some shorts think some insurers will have difficulty meeting policy interest guarantees. From my view, that is not the case with National Western, they have a large amount of long bonds to pro! tect the guarantees.

Thus I say to the shorts: short all you want. You will be buyers at higher levels.

Disclosure: long NWLI and SFG for my clients and me.