For the past three months, retail investors have been a hot topic on Wall Street.
Since mid-January, predominantly young investors and / or newbies in Reddit’s WallStreetBets chat room have been teaming up to buy out-of-the-money stocks and options in shares with high levels of short interest. Short sellers are investors who want to see the stock price fall. Although stocks move in both directions, short selling comes with the added risk of unlimited losses.
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A successful short squeeze requires the right recipe
The goal for these retail investors has been a small squeeze. This is an event in which short sellers (mainly institutional investors and hedge funds) are pressured to step out of their position by a substantial rise in the securities they are betting against. With pessimists rushing to the exit at the same time and needing to buy stocks to cover their position, this tends to exacerbate the bullish movement in a stock.
For example, small squeezes were responsible for sending video games and accessories to the retailer GameStop (NYSE: GME), network of cinemas AMC Entertainment Holdings (NYSE: AMC)and Canadian marijuana stock Sundial Growers (NASDAQ: SNDL) to the moon, metaphorically speaking.
But the dynamics of the short grips are always changing, and what worked for GameStop, AMC and Sundial two months ago is highly unlikely to work now.
For example, GameStop’s sold stake (the total number of shares sold, compared to tradable shares, known as float) dropped from a three-digit percentage in mid-January to 22% in mid-March. Meanwhile, AMC Entertainment and Sundial have short interest rates of just 12% and 10%, respectively.
The other ingredient needed for a short compression is a long day to cover, also known as a short ratio. The longer it takes short sellers to leave their positions, the more likely they are to feel trapped. When this “trap” occurs, it is when stock prices skyrocket. Due to the exceptionally high daily trading volumes for GameStop, AMC and Sundial, short sellers could easily get out of their positions in a matter of hours, if they so wished.
This trio of companies can hurt short sellers
While GameStop, AMC and Sundial are no longer good candidates for a short squeeze, that does not mean that other actions potentially outside the radar are not. The following trio of actions may be prepared to squeeze pessimists.
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Quickly
The first is content delivery and security expert Quickly (NYSE: FSLY), which is one of the fastest growing technology stocks. In mid-March, 20.3 million shares were sold, representing 22% of the company’s float. Most importantly, with an average daily trading volume of 5 million shares, short sellers would take four full days to exit their positions. This is a solid recipe for a short grip.
What is impressive about Fastly (as opposed to AMC, GameStop and Sundial) is that you will find operational growth to support the idea of a small squeeze. With more companies than ever moving to an online presence, the demand for delivering content quickly to end users is only expected to grow. With a usage-based operating model, Fastly should be able to triple its sales in the next four years.
The Fastly business model clearly demonstrated the ability to scale with its customers. The dollar-based net expansion rates for the third and fourth quarters were 147% and 143%, respectively, which indicates that existing customers spent 47% and 43% more than in the previous year’s quarters. The company also has a 99% retention rate.
We are just witnessing the tip of the iceberg for high end cloud stocks like Fastly. Another exceptional quarter of growth may be enough to level short sellers.
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Intercept Pharmaceuticals
Biotechnology stock Intercept Pharmaceuticals (NASDAQ: ICPT) it is another intriguing candidate of short grip. Intercept had 7.24 million shares sold in mid-March, which is equivalent to almost 26% of its float. The key here is that he trades only about 1.16 million shares a day. This implies that it would take more than six trading sessions for short sellers to completely exit their positions if Intercept’s shares rose sharply.
The potential for tightening will depend on experimental treatment with obeticolic acid (OCA) for non-alcoholic steatohepatitis (NASH). NASH is a liver disease that affects up to 5% of the adult population in the United States and can cause fibrosis, cancer or even death. Currently, it has no cure or therapies approved by the Food and Drug Administration.
On the positive side, OCA achieved one of its two co-primary outcomes in the end-stage Regenerate trial – a statistically significant improvement in fibrosis without worsening NASH. On the other hand, the high (and most effective) dose led to increased cases of itching (itching) and considerably more dropouts in the trial than placebo. The FDA sent a complete letter of response to Intercept, requesting additional safety data about the OCA.
With the arrival of new test data, Intercept could destroy or affirm the short sellers’ thesis. Even if OCA is approved for a small subset of the sickest patients with NASH, it could easily become a blockbuster in what was considered a $ 35 billion referral.
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Source
Finally, technology-based insurance Source (NASDAQ: ROOT) has the potential to demand a lot from pessimists. Root had 10.92 million shares sold in mid-March, representing almost 41% of its float. Considering that Root’s average daily trading volume is less than 3.2 million shares, it would take just 3.5 trading days for short sellers to complete their exodus.
The Root car insurance model is unlike anything we’ve seen before. The company is relying on telematics to obtain information about important safety features for drivers before they become customers. By using information derived from the magnetometer, accelerometer and gyroscope on a user’s smartphone, Root can determine how safely or aggressively people drive and offer them a policy based on these extensive metrics.
As you can imagine, the concept is getting a lot of noise, but it is also generating substantial losses at the moment. Root expects its operating losses in 2021 to range from $ 505 million to $ 555 million, with the company stepping up the marketing campaign that was reduced considerably during last year’s pandemic. On the other hand, Wall Street forecasts a fourfold increase in sales between 2020 and 2023, which is not at all negligible.
A small squeeze on Root could be triggered by something as simple as higher-than-expected sales growth, or possibly the company’s better-than-expected loss rates, which would validate its data-based operating model.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even our own – helps all of us to think critically about investing and making decisions that help us become smarter, happier and wealthier.