What happened
Shares of GSX Techedu (GOTU 7.55%) reached all-time highs on Monday, surpassing $50 per share. As of 12:30 p.m. EDT, the stock was up 25%.
GSX Techedu stock is becoming a battle-ground stock. Short interest -- people betting against it -- is surging due to prominent fraud allegations. However, ever since GSX Techedu management started openly disputing these accusations, the stock has rallied nearly 60%, suggesting at least some investors find the explanations reasonable.
So what
Research firms Muddy Waters and Grizzly Research have both issued detailed reports on why they believe GSX Techedu is making up most of its revenue. There's some common threads between the unique research reports. First, the company allegedly doesn't have as many students as it claims as evidenced by login data. That would mean most of its revenue isn't real either. Second, items in Muddy Waters' report were corroborated by an unnamed, former company insider. Grizzly Research's report was similarly aided by anonymous industry insiders.
Both of these research firms published their reports with instructions on how to replicate some of their findings. However, Citron Research took a different approach to GSX Techedu. According to its Twitter account, it's making its case with the Securities and Exchange Commission (SEC) in hopes regulators will investigate.
Luckin Coffee was another popular Chinese growth stock with fraud allegations that were later substantiated. The freshness of Luckin stock's plummet coupled with three prominent short sellers coming out against GSX Techedu caused a surge in short interest for GSX stock. According to ShortSqueeze.com, there are currently 39.3 million shares sold short, up from 26 million before. That's a whopping 66% of the float -- the shares available for trading.
However, GSX Techedu has released three press releases, arguing their side of the story. Management addresses many of Muddy Waters' and Grizzly Research's allegations, providing an explanation for the issues. It's worth noting that since May 19, the day of GSX Techedu's first such press release, the stock has returned almost 60%. It suggests many investors believe the company.
So what does any of this have to do with today? It's speculation, but short sellers may be getting squeezed out, possibly even against their will. Short selling involves margin -- borrowing from your broker. If an investor's position loses enough money, brokers can require them to deposit more money in their account. If they don't, or can't, the broker can close a position at a loss before the loss gets bigger. It's possible that's what's happening with GSX Techedu stock today; short sellers are forced to close, sparking a short squeeze and exacerbating the issue.
Image source: Getty Images.
Now what
Those who find the short case for GSX Techedu stock compelling need to understand that even the best theses, whether bull or bear, often take time to come to fruition. A good thesis will include solid reasoning, consider evidence to the contrary, and be willing to wait long term for it to play out.
July 9 is an upcoming date for investors to circle. The SEC is hosting a roundtable discussion on emerging markets, which include China. It's part of a movement for more scrutiny on foreign-based companies' listing on the U.S. markets. Topics discussed at that meeting could be an indication of where regulation is headed.
