Have you ever made pre-formed biscuits from one of those vacuum-sealed containers? You know, the ones you squeeze and squeeze until that sudden, startling POP? Well, a good short squeeze can give you that same feeling — except your portfolio gets a nice jolt as well.
Netflix, Inc. (NASDAQ:NFLX) is the perfect example of a short squeeze. After a number of gaffes and PR nightmares shook the market’s confidence in the online video giant, Netflix shares began their rapid descent from a high of $300 to a low of $53. At the same time, a large number of shares were sold short, predicting that the company would buckle under its self-inflicted wounds and the rising cost of content.
Fortunately for Netflix’s investors, that was not the case. After reporting strong subscriber growth and beating estimates for Q4 2012, Netflix shares skyrocketed 40% in one day, and have continued to climb since. The meteoric rise in share price forced investors who were short the stock to repurchase their shares, causing the price to climb even more. When a large percentage of the shares outstanding are short, this can lead to an exciting short squeeze.
When to avoid a squeeze
Although short squeezes can really juice up portfolio returns, you should not invest for the sole reason of experiencing a squeeze. In a previous article, I explained why you should stay away from Herbalife Ltd. (NYSE:HLF).
Although I am not invested in the company, I think there is a good chance its shares will experience a short squeeze. As I discussed in the previous article, a number of titans in the hedge fund industry are battling it out over this company.
Bill Ackman of Pershing Square Capital Management went public with a detailed short thesis and announced a $1 billion short position against Herbalife stock. The public announcement sent Herbalife shares tumbling, nearly cutting its price in half.
The story became more interesting when Daniel Loeb of Third Point announced an 8.2% position in the company, and more recently when Ackman rival Carl Icahn announced that he had purchased a 12.9% stake in the company.
With more than 20% of shares outstanding held by well-known money managers and $320 million in cash at the company’s disposal for share buy-backs or special dividends, Herbalife shares may be reaching the breaking point just before the POP!
Don’t touch that dial
Another possible short squeeze you can follow has taken a different path than that of Netflix. Rather than see its share price fall before the squeeze, Sirius XM Radio Inc (NASDAQ:SIRI) turned a $10,000 investment four years ago into more than $250,000. That kind of return changes lives. That said, it seems some investors today do not believe these returns can continue. They’re short more than 400 million shares of the satellite radio company.