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.
Liberty Media Corp (NASDAQ:LMCA), which now has a majority stake in Sirius XM, either owns or has minority interests in a number of other media companies. It recently spun off Starz (NASDAQ:STRZA), a premium movie service with more than 55 million subscribers. Investors may fear heavy selling if Liberty Media were to spin off shares of Sirius to its shareholders. However, with a $2 billion stock repurchase program in place, Sirius XM would be able to buy back 10% of its outstanding shares, significantly increasing the ownership stake of current investors. A program of that size also provides downside protection for the company’s share price by increasing demand for the stock. With a majority stakeholder, high short interest, and a large repurchase program in place, this stock may be ripe for a POP!
A squeeze play in mobile ads
The last short squeeze story you should watch involves the mobile advertising company Millennial Media, Inc. (NYSE:MM). The company’s platform provides more than 30,000 mobile apps with advertising optimization, and decides in real-time which advertisement to display. With more than 300 million users worldwide, the company has seen its revenue grow from $6 million in 2008, to $177.7 million in 2012.
Millenial’s story may be an instance where the short sellers are right. After it forecast 2013 revenues below analysts’ expectations, the company’s shares fell as much as 33%. On the other hand, 71% year-over-year revenue growth is nothing to sneeze at. With nearly 10% of its outstanding shares currently short, this may turn out to be an interesting story.
Again, you should not invest in a company simply because you believe it may experience a short squeeze. In some instances, the shorts end up being on the right side, as we are seeing with Millenial Media. In the case of Netflix, I did not believe the company was doomed, and I felt its share price did not properly reflect the company’s growth potential. The subsequent short squeeze was icing on the cake.
Short squeezes are beneficial stories to follow, because I believe there is something to be learned from the events leading up to the squeeze. As the saying goes, history doesn’t repeat itself — but it does rhyme. Recognizing the events that cause a stock to either rocket or plummet may help your portfolio one day.
The article Short Squeeze? Yes, Please! originally appeared on Fool.com and is written by Kyle Campbell.
Copyright © 1995 – 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.