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.

SeaWorld Entertainment Inc (NYSE:SEAS)

Shares Being Shorted (as of April 30): 23.98 million

Percentage of Float Being Shorted: 37.4%

Days to Cover Shorts (Based on Average Daily Trading Volume): 18

Bear Thesis on SeaWorld Entertainment Inc (NYSE:SEAS): Negative publicity of SeaWorld reached a feverish pitch in 2013 with the release of the documentary Blackfish, which criticized the theme park’s capture and handling of killer whales. Short sellers of the stock believe that the company will not be able to restore the public’s perception of it and that attendance and revenue will continue to decline.

Why the Bears Are Wrong: The shorts are starting to feel the heat on this one, as SeaWorld shares have gained over 50% since touching an all-time low last November. Attendance jumped in the first-quarter by 15% year-over-year, while revenue rose by 16.5% as the company’s new attractions appear to be gaining traction with visitors.

Rather than hide from or skirt around the controversies that have dogged it in recent years, as shorts may have been banking on, SeaWorld has instead used the opportunity to do a little soul searching and change its messaging as well as completely overhaul the content of its shows. While the results have been slow to take root, SeaWorld Entertainment Inc (NYSE:SEAS) appears to be on the right track. Aggressive new pricing and marketing strategies have also helped spur a renewed interest in the park.

As rapidly as public perception can turn against a company, it can just as quickly do the opposite. And as with all controversies, they eventually fade from public view. While Blackfish may continue to haunt SeaWorld to some extent for a little while longer, any threat of it being the company’s death knell have passed, and its influence will only continue to wane as SeaWorld transitions further and further away from killer whales as the backbone of its attractions.

Shake Shack Inc (NYSE:SHAK)

Shares Being Shorted (as of April 30): 7.78 million

Percentage of Float Being Shorted: 32.2%

Days to Cover Shorts (Based on Average Daily Trading Volume): 14

Bear Thesis on Shake Shack Inc (NYSE:SHAK): Bears don’t understand what all the fuss is about. After all, Shake Shack is just a burger joint in a world where McDonald’s Corporation (NYSE:MCD) exists. They groan when people talk about its growth rate compared to other restaurants, restaurants which have been around for a million years already (give or take a few hundred thousand). And they get light-headed when thinking about the company’s sky-high valuation.

Why the Bears Are Right: This is another stock that’s hurt bears in a big way this year, but unlike SeaWorld, which has risen into fair valuation territory, Shake Shack continues to push into nosebleed territory. Shake Shack is now valued at over $2 billion after 33% gains this year. That’s the same market cap as GameStop, despite the company pulling in 1/24 the revenue that GameStop did last year.

Yes, there’s a growth story here, which included opening a net total of 45 new locations in 2017, not just in the U.S, but in Japan, the U.K, and the Middle East as well. All told, the company is aiming to have 450 locations at some point in the not-too-distant future. Far less impressive was the company’s same-store sales decline of 1.2% (though that figure did rise by a modest 1.7% in the first-quarter of this year) and its operating income of less than $34 million (shares trade at 63x that figure).

Of course, we know that the markets don’t always react rationally when it comes to growth stocks (or ever for that matter), so trying to short them is always a risky endeavor. Nonetheless, while it might not be in a year, as of right now the data says this is an overvalued stock.

Disclosure: None