Investors may be surprised to learn that the best-performing stocks this year are also among the most heavily shorted. In fact, “short-sellers are facing their worst losses in at least a decade,” according to The Wall Street Journal . Let’s look at what this means for long-term investors, and examine one stock that could pop if shorts have to pay up.
Short story
Short-sellers make money betting against stocks. They borrow shares from a broker, then immediately sell those shares, only to buy them back later at a (hopefully) lower price. Ideally, the short-seller profits from the difference. But if that stock goes up, short-sellers must cover their positions by buying back the stock at a higher price, incurring a loss in the process .
When many short-sellers cover their positions in a stock at the same time, this leads to a short squeeze — a surge in the stock’s price. Tesla Motors Inc (NASDAQ:TSLA) is a great example of this.
Tesla Motors Inc (NASDAQ:TSLA) investors have enjoyed a few short squeezes this year, thereby profiting from short-sellers’ shortcomings. In fact, the stock has gained more than 377 % year-to-date, which is quite a transformation from a year ago, when it was the fourth-most-shorted stock in the market .
Tesla Motors Inc (NASDAQ:TSLA)’s CEO, Elon Musk, spoke to us at Motley Fool headquarters in 2011, when the stock was trading around $24 a share . When asked what he’d say to investors shorting it, he responded, “It’s going to burn.”
I bought the stock at $27 a share, shortly after meeting Musk at Fool HQ. At the time, many investors saw Tesla Motors Inc (NASDAQ:TSLA) as a risky bet — in part because of its high short interest. I saw a brilliant CEO with a disruptive product. Not only did Musk have something to prove, but he also had a clever management team to back him up. True, Tesla Motors Inc (NASDAQ:TSLA)’s stock was an appealing short squeeze candidate because it had a high short float. However, I also believed in the fundamentals of its business.
As Tesla Motors Inc (NASDAQ:TSLA)’s stock gained speed this year, Musk tweeted, “Seems to be some stormy weather over in Shortville these days .” The stock hasn’t looked back since. Shares of Tesla now trade around $167 apiece.
The contrarian
It’s not enough to buy a stock with high short interest and blindly hope that the shorts got it wrong. If we dig deeper into the 50 stocks with the largest short interest as a percentage of market cap, 3D Systems Corporation (NYSE:DDD) stands out. The 3-D printing pioneer has a strong underlying business, despite the large number of short-sellers betting against it. In addition, the market for additive manufacturing or 3-D printing is expanding every day. Let’s evaluate what this company is doing right, and why the shorts may be in trouble.
For comparison, here’s a quick look at how 3D Systems Corporation (NYSE:DDD)’s short interest measures up to rivals in the space.
| Company | Forward price-to-earnings | Short Interest as a % of Market Cap | Total Return YTD |
|---|---|---|---|
| 3D Systems | 37 | 27% | 30% |
| Stratasys (NASDAQ:SSYS) | 40 | 12 % | 30 % |
Source: Data from Finviz.com and Goldman Sachs .
