Short selling, or selling borrowed shares of a stock with the hopes of buying it back later at a lower price, isn’t easy. In theory, short sellers can experience unlimited losses due to a “short squeeze.” For bears in stocks with heavy short interest, having your position squeezed represents a serious risk.
In a short squeeze, better-than-expected news can lead a stock higher, which forces short sellers to cover their trades. If there are too many short sellers (or too few shares), it may trigger a margin call that sends the stock higher. Theoretically, a short squeeze can cause equities to outrun their fundamentals, moving the price much higher and sending shorts running for cover.
For that some reason, some investors screen for stocks with heavy short interest as potential contrarian buying opportunities. Even large-cap bull plays such as Alibaba (NYSE:BABA) and Tesla (NASDAQ:TSLA) often rely, at least in part, on short-covering as a potential catalyst.
These 10 stocks all qualify as heavily shorted shares. By this definition, all 10 stocks to buy in this list have at least 20% of their float sold short, providing fuel for a squeeze.
All admittedly have some risk, which is why short-selling traders have targeted these stocks in the first place. All ten have the potential for bullish catalysts that could squeeze the shorts and create big gains for investors willing to take the other side of the trade.
10 Stocks Set Up for a Short Squeeze: RH (RH)
High-end furniture retailer RH (NYSE:RH) has been an epic battleground stock for several years now. For most of the past five years, over 20% of the company’s shares have been sold short — a figure that now sits at 34%. RH itself has countered by buying back $1.25 billion in stock in the last two years, which helped ignite an enormous rally from $20 in early 2017 to $160 in the middle of last year.
Since then, however, the shorts have been on the right side of the trade. RH stock trades at an 11-month low and has dropped 38% from its 52-week high. As Luke Lango detailed last month, RH stock looks intriguing at these levels.
Valuation is attractive, with RH trading at less than 11x next year’s EPS estimates. The company’s efforts to drive membership and build out high-end restaurants appear to show early results.
The housing market and macro worries have had an impact, but at least in the near term, demand seems like it should remain at least stable. There’s a solid fundamental case back near $100. And with short interest still above 30%, it may only take one good quarter to send RH soaring again.
Brinker International (EAT)
Like RH, Chili’s owner Brinker International (NYSE:EAT) has tried to fend off shorts in part by repurchasing shares. This decade alone, Brinker has reduced its share count by over 60%.
But Brinker’s strategy hasn’t been quite as effective. EAT stock actually is down about 15% over the past five years, and including dividends, shareholders over that period have roughly broken even. And short sellers are taking increasing aim at the company, with roughly one-third of the float sold short at the moment.
There is a seemingly solid short case here: I’ve actually sold the stock short myself, and I called EAT stock “toxic” last year. That said, Brinker has shown some signs of life lately. A slimmed-down menu has improved service and back of the house efficiency. Same-restaurant sales are improving. Food delivery represents a new potential revenue stream. And Brinker shares are cheap, with a forward P/E close to 10x and a dividend yield of 3.6%.
There are risks here, with a large debt load (driven in part by those share repurchases) and worries that consumer tastes are moving away from casual dining chains. But with such a large short float, and expectations low, a few more quarters like that last two could cause shorts to move on – and potentially push EAT back to recent highs above $50.
Canopy Growth (CGC)
The most valuable marijuana stock, Canopy Growth (NYSE:CGC) unsurprisingly has attracted its share of short sellers — 35% of the stock’s float is sold short.
To be sure, Canopy has a relatively thin float: only a little over one-third of its shares are freely traded. Notably, Constellation Brands (NYSE:STZ, NYSE:STZ.B) owns nearly 40% of the company after investing $4 billion last year. Still, short sellers have targeted CGC — and surprisingly so given recent history.
After all, smaller pot play Tilray (NASDAQ:TLRY) saw an epic short squeeze last year. And while CGC isn’t going to see the same type of run — at one point, TLRY doubled in four sessions — more good news for the company, or more optimism toward the industry, could lead to a rush to a crowded exit.
CGC already has had a good 2019, perhaps aided by short covering. There are enough traders still betting against Canopy Growth to keep the stock moving higher if the company, and the industry, keep posting impressive growth.
Cybersecurity provider SecureWorks (NASDAQ:SCWX) has about 30% of its float sold short … but here, too, the size of the float amplifies the role of short sellers. Dell Technologies (NASDAQ:DELL) owns some 85% of SecureWorks, meaning only a small slice of the available shares actually are traded.
That thin float makes SCWX ripe for a short squeeze, and it’s possible the stock already has seen a squeeze this year. Starting in late January, SCWX moved from $16 to $24 in just two weeks on essentially no news. The stock has given back some of the gains, driven in part by somewhat disappointing Q4 earnings, but there’s still room for another spike higher.
There’s also an intriguing growth story here. I called out SCWX as a cybersecurity stock to watch back in early April. The sector is hot, and SecureWorks seems to have carved out an attractive niche in threat detection and response. In this market, and in that industry, a 3x price-to-revenue multiple is reasonable and leaves room for upside.
With shorts potentially trapped if SCWX starts to move, it wouldn’t take much for the stock to make another big run.
Source: Shutterstock At this point, LendingTree (NASDAQ:TREE) looks like a trade, not an investment. But for investors willing to take the risk, the gains could be impressive.
After all, TREE stock has made huge moves in recent years. It spent most of 2016 hovering around $100. After the U.S. presidential election (amid a roaring bull market), TREE took off. It touched $400 in late 2017, in part because 32% of shares outstanding were sold short at the beginning of the year. Twelve months later, roughly two-thirds of those shorts had capitulated.
TREE gave back a good chunk of its gains last year, however, falling 50% at one point. But the rally has resumed: the stock has nearly doubled just since mid-December. And short interest is rising again.
From a fundamental standpoint, TREE admittedly looks potentially overvalued at 40x 2020 consensus EPS estimates. But the chart looks attractive and 25% of the float is currently sold short.
That’s a lot of traders that will need to cover if the rally keeps going. Nimble traders, then, might see TREE as an ongoing squeeze and make a bet that 2019 will wind up looking much like 2017 did.
BlueLinx Holdings (BXC)
Short sellers have piled into the bearish side of the trade on BlueLinx Holdings (NYSE:BXC). Short interest was basically zero at the beginning of 2018. In March of that year, BlueLinx merged with fellow building products distributor Cedar Creek. BXC stock soared, and kept soaring: it would close the first quarter up some 219%.
The gains attracted bets against the stock, however, which have continued to rise. And there are worries here. Housing demand has been choppy of late. Bluelinx, like most distributors, still has low margins, and debt remains an issue for the combined company.
But there’s also a lot to like here. Bluelinx continues to hold quite a bit of valuable real estate — some of which can be sold to pay down debt. Valuation is cheap, particularly with BXC well off September highs around $40. And with short interest rising, it doesn’t take much to spike the stock: indeed, BXC rose 11.8% after a decent, but unspectacular, earnings report this week.
Should performance stay decent — or improve — for the rest of the year, short sellers may regret their trade.
Turtle Beach (HEAR)
Headset manufacturer Turtle Beach (NASDAQ:HEAR) seemed near the edge of bankruptcy in 2017. The company had a niche in gaming headsets but it also had quite a lot of debt and little, if any, growth.
The rise of Fortnite, which hit video game stocks like Activision Blizzard (NASDAQ:ATVI), turned out to be a godsend for Turtle Beach. At one point, HEAR stock had risen 2,000 percent in 2018. But here, too, the big gains attracted short sellers, who bet that the growth driven by Fortnite would quickly fade and eventually reverse.
That case made some sense and seemed confirmed by the company’s seemingly disappointing guidance for 2019. But the selloff in HEAR looks like it has gone too far, one reason I sold puts on the stock earlier this year. Turtle Beach still is guiding for around $1 in EPS this year. That guidance was maintained after this week’s first-quarter earnings report and suggests the stock is trading at around 10x earnings.
Battle royale games still should drive demand going forward. Headsets sold to Fortnite players in 2018 will need to be replaced later this year and into 2020. Most notably, even if 2018 was a one-off performance, it had a long-term benefit: Turtle Beach has paid off its debt and retired preferred stock.
The reaction to Q1 earnings — HEAR initially jumped double-digits, but gave back its gains — does undercut the case for a near-term squeeze. This likely is an argument over 2020 and beyond, and one not necessarily solved by earnings in 2019. But there’s still a huge amount of shares sold short and a solid fundamental case for HEAR. That’s an attractive combination at $10.
Ubiquiti Networks (UBNT)
The question with networking pioneer Ubiquiti Networks (NASDAQ:UBNT) might be whether the short squeeze is over. UBNT has gone vertical this year, gaining 57% already in 2019. Shorts have scattered: short interest is at a five-year low at the moment.
Again, due in part to a thin float, some 28% of the float is sold short. And there’s more pressure coming. Ubiquiti continues to take market share. Growth is impressive, and there’s no sign of letting up.
At this point, one might think short sellers would have learned. Citron Research called Ubiquiti a “fraud” back in 2017. The stock since has nearly tripled. As long as Ubiquiti keeps performing, the remaining shorts may be in for similar pain.
Tivity Health (TVTY)
The decline in Tivity Health (NASDAQ:TVTY) truly has been stunning. In December, the company announced a $1.3 billion deal to acquire Nutrisystem, combining the diet provider with its own fitness programs (notably senior-focused SilverSneakers).
By late March, TVTY had lost roughly $1 billion in market value. There was a case that Tivity overpaid but the amount and the speed of value destruction seemed far too high.
TVTY has bounced 24% from its lows despite an 11% decline Thursday following first quarter results. But the quarter seems acceptable, albeit not spectacular, and the current valuation still leaves plenty of room for upside. TVTY still trades at less than 9x 2019 consensus EPS with more merger-related cost savings on the way in 2020.
Short sellers don’t see it that way: fully a quarter of Tivity’s outstanding shares are sold short at the moment. And with Q2 earnings now three months off, investors may need some patience in waiting for a squeeze. But covering could drive TVTY higher in coming sessions. And if the company can validate its acquisition by integrating the two businesses and driving revenue synergies, that short interest could be fuel for a big rebound in TVTY shares.
AMC Networks (AMCX)
The market doesn’t seem quite sure what to do with AMC Networks (NASDAQ:AMCX) – and I’m inclined to agree. I’ve owned AMCX stock in the past, generally aiming for $50 as a buy point. That’s proven to be the low end of a range that’s held for about three years now, with AMCX mostly moving between $50 and $65.
At $55, AMCX is toward the middle of that range and quite a few traders see it as overvalued. Some 20% of shares outstanding, and 25% of the float, are sold short. It’s not hard to see the bear case. Flagship franchise The Walking Dead has seen ratings fall steadily. Cord-cutting and the rise of streaming services like Netflix (NASDAQ:NFLX) present risks to viewership and ad dollars.
That said, AMCX is awfully cheap, at about 6.5x 2019 EPS estimates. There’s still a case that a larger media company could look to buy the company out; even a rumor could lead shorts to cover and AMCX stock to spike. AMC Networks, too, has been aggressive in repurchasing shares, further tightening the float and creating the potential for a squeeze.
For now, AMCX looks like a trading stock, as it’s been for the past few years. But with valuation reasonable, it’s a trading stock worth a look on a fundamental basis as well.
As of this writing, Vince Martin is long shares of Dell Inc., has a bullish options position in Turtle Beach, and has a bearish options position in Tesla. He has no positions in any other securities mentioned.
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