Hey Insiders,
This weekend, we will be looking at U.S. stocks with high short interest by popular request. These have become stocks of interest to many retail investors since the outsized returns realized by individuals backing AMC, GameStop, and others in 2020 and 2021, when these stocks had significant short interest percentages.
The reason these stocks have such high potential is purely due to the mechanics of shorting a stock. To short a stock, you borrow the stock from someone who owns it and pay them interest. (So if Company X has a stock trading at $100, you can borrow that stock at 5% interest and pay the owner $5 per year.) As the short seller, you are betting on the price of that stock decreasing, so once you have the stock, you then sell it for $100. You plan to wait for it to fall and buy it back at $50 after two years. By then, you will have paid $10 in interest and $50 to repurchase the stock, which you return to the lender, putting your costs at $60. Because you originally sold the stock at $100 when it was overvalued, you earn a profit of $40.
The reason these stocks can be vulnerable is that if you borrow when the stock is at $100 and the price starts going up, you eventually will need to buy back the stock at a higher price than $100. You then lose not only the difference between the price when you sold it and repurchased it but also the interest.
A short investor can't just wait for the price to go back down because mounting losses will usually trigger a margin call, which is when the investor is required to put up more collateral immediately. That forces the issue and usually requires the investor to buy back the shares and return them to the lender to satisfy the loan.
If 50% of all shares in a company are shorted, this means that when prices start rising, half of the outstanding stock will need to be purchased by short sellers for them to cap their losses and exit their positions. In essence, if enough people realize the short float is high and work to raise the stock price, they put short sellers in a position where they are all rushing to buy back the stock to cap their own losses, so the short sellers are the ones who then push the price up. This all leads to a crash in the end, but significant sums can be made in the short term for the investors who weren't the ones left holding the bag.
Today and tomorrow, I'll look at companies with high short interest and relatively low market cap. The high short interest makes them vulnerable, while the low market cap means fewer people need to participate to push up prices.
As always, if you have any comments or suggestions for future trends to investigate, please reach out on Twitter.
Onward and Upward,
