Why Shorts Are Dead Wrong About These 2 Stocks (and Right About This 1)

Short selling stocks is never easy at the best of times, less so when the market is in the midst of a nine-year bull run and historically low interest rates help prop up suspect companies. Even then, when things seem all but lost for a company and its stock, some cursed white knight could swoop in and buy the company at the last second, pulling the final nail out of its coffin and tossing it in the short seller’s face.

However, the tide may finally be turning for short sellers, who point to rising interest rates and greatly enhanced volatility this year as reasons for optimism (or optimistic pessimism as it were). Rising rates will finally separate more of the chaff from the wheat, while making the chaff far less valuable to prospective buyers.

Alternatively, short sellers could simply be wrong in their theses on certain companies, which we believe is the case with two of their three favorite targets as of the end of April, which are GameStop Corp. (NYSE:GME), SeaWorld Entertainment Inc (NYSE:SEAS), and Shake Shack Inc (NYSE:SHAK). We’ll take a look at why they dislike these stocks below and why they’re wrong about two of them (and right about one of them).

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GameStop Corp. (NYSE:GME)

Shares Being Shorted (as of April 30): 41.13 million

Percentage of Float Being Shorted: 41.6%

Days to Cover Shorts (Based on Average Daily Trading Volume): 11

Bear Thesis on GameStop Corp. (NYSE:GME): Revenue will continue to decline as digital game sales eat into physical sales, which will also impact the company’s higher-margin used games business. The company’s other revenue streams (collectibles, tech) won’t be enough to save it once its core games business collapses, which includes video game consoles finally going the way of the dodo after this generation.

Why the Bears Are Wrong: While some of those points are certainly legitimate when looked at without any further context, they don’t address the fact that GameStop shares are ridiculously cheap right now, trading at just 60% of the company’s book value. The shares also sport an obscene forward yield of over 11% that is in absolutely no danger of being cut, with a payout ratio below 50%.

One must believe GameStop is headed for bankruptcy to short shares that are this cheap, yet its balance sheet is not in any kind of dire straits unless one assumes an imminent earnings collapse, which shows no signs of occurring despite the fact that GameStop has refrained from propping up its EPS by buying back stock (although now would be a great time for it to do so).

On the console front, we’ve been told for a decade that video game consoles would be a thing of the past by now, with many a pundit having emphatically claimed that there wouldn’t be another console generation after the last one. Oops. They’re still here and there’s no reason to suspect there won’t be another generation after this one. In fact, current generation console sales are outpacing sales of the previous generation and are being further aided by more expensive enhanced consoles and VR headsets. Until there’s a legitimate reason to think consoles have limited commercial prospects going forward (and there isn’t a more legitimate reason now than there was then), the flawed assumption that consoles are a thing of the past needs to finally die.

On the next page we’ll look at two other heavily shorted stocks, one which bears have wrong, the other not so wrong.