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 .
As you can see, short interest in 3D Systems Corporation (NYSE:DDD) is markedly greater than that for rival 3-D printing company Stratasys, Ltd. (NASDAQ:SSYS), in part because of investors’ concerns about 3D Systems Corporation (NYSE:DDD)’s acquisition spree. The company has issued stock and debt offerings to cover such acquisition costs , which could mean added risk for shareholders if the share count keeps getting diluted . Nevertheless, 3D Systems Corporation (NYSE:DDD)’s debt looks manageable at this point, particularly given the growth opportunities on the horizon.
Printing money
3D Systems Corporation (NYSE:DDD) got more attention Monday, when Citigroup analyst Kenneth Wong gave the stock a buy rating and said it could climb to $60 a share. The stock hit an all-time high of $54.08 on the news — hurting short-sellers.
Why shouldn’t investors be optimistic about 3D Systems? The company is one of the largest players in the $2 billion 3-D printing market, which Wong believes will grow threefold by 2018 . Likewise, 3D Systems’ future earnings could continue grow in tandem with this market.
Additionally, 3D Systems is fueling future growth through product innovation. So far this year the company has introduced four printer products, nine ProJet models, and two new consumer focused printers called Cube and CubeX . To ensure these products sell, 3D Systems is expanding its global reseller network. It added Synnex Corporation to its list of sellers in May and before that Seiko-I Infotech, which operates 11 locations in Japan . Expanding its reseller reach around the world should bolster sales for 3D Systems going forward.
Recent advances in three-dimensional printing technology let consumers print prototypes and products from materials including plastics, waxes, metals, and composites, among others . These machines also help manufacturers from all walks of industry cut down on labor costs.
General Electric Company (NYSE:GE) is the latest multinational conglomerate with plans to deploy the technology on a large scale. The company has been using 3-D printing machines to produce fuel nozzles for the LEAP engine, which General Electric Company (NYSE:GE) produces for use in Boeing’s 737-MAX jets. By leveraging additive manufacturing on an industrial scale, GE is able to significantly reduce production times and save money . This is one of many examples of how 3-D printing is increasingly changing the way large companies make products around the world.
3D Systems grew annual sales 47.8% in the last year by offering a broad portfolio of 3-D printers at a variety of price points . As the market for additive manufacturing grows, so, too, should this company’s share of it.
Foolish Takeaway
3D Systems’ diverse lineup of products and prices make it appealing to both consumers, as well as, corporations. Given these catalysts, I think the stock’s high short interest is largely undeserved, and with 27% of its shares now sold short the stock is vulnerable to a short squeeze.
We’ve seen Tesla’s stock create billions in market value this year, as the company exceeded expectations and short-sellers were forced to buy back millions of shares . “The gains illustrate what’s possible when negative sentiment builds in a company and management is able to avoid disappointment,” Bloomberg reported.
Similarly, if 3D Systems is able to continue growing its reseller network while delivering innovative products, I suspect the shorts will rush to cover their positions.
The article 1 Heavily Shorted Stock That’s Poised to Pop originally appeared on Fool.com and is written by Tamara Rutter.
Fool contributor Tamara Rutter owns shares of Tesla Motors. The Motley Fool recommends 3D Systems, Stratasys, and Tesla Motors. The Motley Fool owns shares of 3D Systems, General Electric Company, Stratasys, and Tesla Motors and has the following options: short January 2014 $36 calls on 3D Systems and short January 2014 $20 puts on 3D Systems.
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