1 Heavily Shorted Stock That's Poised to Pop

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 (NASDAQ: TSLA  ) is a great example of this.

Tesla 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'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 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'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'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 (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' 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 is markedly greater than that for rival 3-D printing company Stratasys, in part because of investors' concerns  about 3D Systems' 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' debt looks manageable at this point, particularly given the growth opportunities on the horizon.

Printing money
3D Systems 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  (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 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 Opportunities in Additive Manufacturing

With the U.S. relying on the rest of the world for such a large percentage of our goods, many investors are ready for the end of the "made in China" era. Well, it may be here. Read all about the biggest industry disrupters since the personal computer in 3 Stocks to Own for the New Industrial Revolution. Just click here to learn more.


 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Read/Post Comments (6) | Recommend This Article (10)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 29, 2013, at 1:08 PM, Brian2003 wrote:

    The issue with Tesla is valuations over time ALWAYS come in to line. First Solar was a good example of irrational exuberance as is Tesla's current valuation. Tesla's valuation equates to over $1,000,000 in market cap for every car sold. If Tesla can keep selling cars, they hope to sell 22,000 this year. The stock has an insane valuation and impossible to get any return on investment. Over time reality comes into play and the momentum slips away. Good luck Tamara.

  • Report this Comment On August 29, 2013, at 1:13 PM, EvanBuck wrote:

    @Brian I agree.

    What do you guys think about another 3D printing company, Perceptron (NASDAQ:PRCP)? I bought some shares at 8 bucks plus change apiece and today the company announced a very solid quarterly report (shares are rocketing up 25%+).

  • Report this Comment On August 29, 2013, at 2:02 PM, ckgod wrote:

    Brain2003 When you people keeps on saying valuation you lost sight of why people invest, in particular invest in a growth company. For example did you ever hear VC's talking current valuation when they invest? All the care is what the company worth when it fully grown up.

  • Report this Comment On August 29, 2013, at 2:19 PM, MountainEdge wrote:

    The casino continues with the analysts ignoring over a 100 percent increase in capital, an opaque management style and over 34 acquisitions over the past three years. I loved to know how organic growth is calculated given management's claim that the integration of 34 acquired companies is going well. Oh yes, that explanation of the increase in AR is a concern.

    Do not worry this company will continue to growth through acquisitions. The only problem is that the acquired companies are getting more expensive.

    I

  • Report this Comment On August 30, 2013, at 6:05 AM, strelna wrote:

    Exhibits the usual TMF lazy preference for words instead of numbers in presenting a valuation call. You need to show why DDD is undervalued in view of prospective numbers. The mere statement 'great company; shorts are wrong!' is worthless. If a proper case is there to be made, why not make it?

  • Report this Comment On August 30, 2013, at 3:28 PM, TMFBos wrote:

    @Evanbuck

    Not sure where you got your information but Perception has no 3D printing business to speak of. It appears they're a 3D scanning company for quality control in automotive assembly lines.

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