Easy Come, Easy Go

For a few hours at least, the largest company in the world was not longtime top dog Exxon Mobil (NYSE: XOM  ) . Leading retailer Wal-Mart (NYSE: WMT  ) and software giant Microsoft (Nasdaq: MSFT  ) weren't even close. Instead, it was German automaker Volkswagen AG (OTC: VLKAY.PK).

It's a valuable lesson in low-liquidity investing, and a short squeeze of epic proportions.

Last week, Volkswagen was simply one of the largest automakers available anywhere. The stock is not trading on the NYSE or Nasdaq -- probably to avoid Sarbanes-Oxley headaches -- although a few shares trade hands on the bulletin boards. The company had a very respectable market cap in the $100 billion range for most of 2008. Index funds own the lion's share of VW's stock, and about 13% of the shares were sold short after the share price tripled in two years.

So when Porsche announced that it had acquired 74% of Volkswagen's stock and options, there was no free float left to speak of -- the sports car expert had snapped up most of it. The short sellers wanted to buy back their borrowed shares but couldn't find anybody who'd sell. In a blind panic, hedge funds and individual investors increased their bids until the buyers started to notice.

And an overnight four-bagger was born. At the peak of the trading fury -- at very heavy volume -- VW's market topped out at $364 billion. The market caps of Bank of America (NYSE: BAC  ) , Pfizer (NYSE: PFE  ) , and Toyota (NYSE: TM  ) combined don't add up to that much.

Somebody made a lot of money that day, and someone else lost just as much. The next day, VW fell over 40%. Another bunch of fortunes made and lost.

Volatility can be your friend, but it can also crush your portfolio if taken to extremes. Nobody in their right mind would call Volkswagen the most important company in the world, but when the short squeeze strikes, there's no getting away from the insanity. Some trades are forced by margin calls, as a $10,000 short sale turns into a $30,000 loss when the share price quadruples overnight. The risks multiply when there's little or no float in the stock, and Volkswagen hit the triple jackpot. Don't let that happen to you. And if you're thinking about getting rich from that incredible spike, well, good luck. It'll take crackerjack timing and another perfect storm.

Further Foolishness:

Pfizer and Bank of America are Motley Fool Income Investor picks. Wal-Mart, Pfizer, and Microsoft are Motley Fool Inside Value picks. The Fool owns shares of Pfizer. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Anders Bylund holds no position in any of the companies discussed here. You can check out Anders' holdings or a concise bio if you like, and The Motley Fool is investors writing for investors.


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