Stock Market Wrap-Up: The Real Reason Aurora Cannabis Stock Lit Up on Monday

The stock market soared on Monday, lifted by fresh enthusiasm about the possibility of the U.S. economy getting back to normal. Despite concerns from health officials, many states are moving forward with plans to reopen at least partially, and the resulting boost in economic activity has investors hoping for the best. The Dow Jones Industrial Average (^DJI 0.06%), S&P 500 (^GSPC -0.22%), and Nasdaq Composite (^IXIC -0.52%) were all sharply higher on the day as a result.

Today's stock market

Data source: Yahoo! Finance.

Yet gains of 2% to 4% for the major benchmarks were nothing compared to the big pop that pot stock Aurora Cannabis (ACB 12.87%) enjoyed. Even after pushing sharply higher on Friday following its late-Thursday quarterly-earnings report, Aurora built on its gains with an advance of more than 50% on Monday. With so much conflicting information in terms of fundamentals of Aurora's business, it's highly likely that an unrelated factor played a big role in the rise for the cannabis stock.

How Aurora fared to start 2020

The fiscal third-quarter financial report from Aurora Cannabis last week gave investors some nice surprises. Sales climbed 35% from where they were three months ago, which was quite a bit better than the single-digit percentage growth that most shareholders had expected to see.

Image source: Getty Images.

Aurora also managed to reduce its operating costs. A nearly 20% decline in overhead expenses helped the bottom line, as did a more than 50% cut in stock-based compensation charges. Those cost-control measures helped slow the rate at which Aurora is burning through its cash reserves, and the pot company hopes that it can post positive financial results after taking interest, taxes, depreciation, and amortization charges into account within the next six months.

However, it's important to note that Aurora is still losing money at an alarming rate. The cannabis company also faces ongoing challenges, including sluggish international business performance, rising inventory levels, and operational issues related to the COVID-19 pandemic.

Getting squeezed

If Friday's gains had something to do with Aurora's earnings report, Monday's jump likely came from investors putting the squeeze on short sellers. Selling pot stocks short worked well in 2019, earning institutional investors almost $800 million, and Aurora in particular has had a considerable number of shares sold short for a long time.

Moreover, Aurora's decision to do a reverse stock split earlier this month probably led some investors who'd made money on the short side of the stock to double down on their bets. When Aurora's stock price went below $1 per share, it became a lot more difficult for investors to short effectively. The 1-for-12 reverse split suddenly made it easier again. Almost 19 million Aurora shares were sold short as of April 30, according to split-adjusted figures from Yahoo! Finance. With about 110 million shares outstanding, that works out to roughly 17% short interest.

Cannabis investors have seen this before. Tilray (TLRY) saw its stock soar to $300 per share in 2018 before falling back to earth, as skeptical short sellers found themselves on the wrong side of huge amounts of volatility. They were eventually proven right, as Tilray now trades at less than $8 per share. However, the squeeze forced many of those short sellers out of their positions at exactly the worst time.

Many companies have continued to struggle after doing reverse stock splits, so the bet short sellers made wasn't irrational by any means. Yet anytime a stock has high short interest, it can climb quickly in response to surprisingly good news. That appears to be what's happening now -- and it could lift the post-reverse split share price for Aurora well above where it trades today. Then, the question will become how long the marijuana stock  decides to wait before doing its next secondary stock offering.