In the last stock market crash, shares of Carvana (CVNA -3.56%) and SmileDirectClub (SDC 5.16%) were hit exceptionally hard. On March 24, Carvana was down 61% year to date and SmileDirectClub was down 55%.
A big reason these two stocks were slammed was that opportunistic short-sellers were betting against the stocks in high numbers, evidenced by their respective high short interests. And when the market is crashing, the shorts really pile on, which can send share prices down in a hurry.
While this can be painful for buy-and-hold investors, the important thing to remember about short-sellers is that they are all future buyers. That's because they have borrowed the shares in order to sell them short, and they will eventually need to buy the shares back to close the position. So if you're attempting to buy during a crash, it's not a bad idea to look for strong companies with heavy short interest. When the market becomes positive again, these stocks can really soar.
Carvana has a huge market opportunity
Carvana is an online retailer that sells used cars. The company is most famous for its car towers, or 'car vending machines.' It's a distribution mechanism but also (and more importantly) a great marketing idea. The car towers drive people to the website, which has made Carvana synonymous with online car buying.
When a dominant retailer with a new concept comes along, the stock returns can be amazing. Walmart was like that, with its "big box" concept. And then Amazon was a top dog and first mover in e-commerce. Carvana has taken this concept and is using it in a specific (and huge) vertical that Amazon doesn't touch.
As a retailer, Carvana is a very cheap stock, trading at just three times sales. The company has had almost $5 billion in revenues in the last 12 months, and its growth rate is still very high at 40%. The company is on the verge of profitability with a net profit margin of (3%).
Yet investors are still shorting the stock. While a lot of shorts were squeezed out of Carvana's stock earlier this year, the short interest is still high -- 28% of the float is sold short today. This high short interest makes the stock volatile. But if you're confident about your investment thesis, high short interest is attractive. You have a ready moat of future buyers, and if any good news hits the market, traders will swoop in and take easy profits by squeezing the short-sellers (which makes the stock soar). This happened to Amazon back in the day, and to Tesla for a long time.
Why are people shorting Carvana? Probably for the same reason so many shorted Amazon in its early days -- it's a retailer (thus it has low profit margins), and it's currently unprofitable. Yet this overlooks a real positive for retailers -- these companies have huge potential markets. The global used car market is worth $1.3 trillion. And of course, digital retail is superior to brick-and-mortar, and a huge chunk of this market is moving online, a transition being accelerated by the pandemic.
Short interest is simply a trading dynamic to be aware of, and it doesn't tell investors what stocks to buy. But high short interest can be helpful in determining when to buy an investment you believe in. As we've seen in 2020, a great time to buy Carvana is when the market is crashing and short-sellers are pressuring the stock downwards.
SmileDirectClub is up 171% since the first coronavirus crash
SmileDirectClub sells clear and removable retainers that straighten teeth. Like Carvana, SmileDirect is going after a huge market opportunity with 85% of people in the world having malocclusion (misalignment of teeth). Only 1% of those receive treatment annually and the company thinks it can help 90% of those with malocclusion to achieve a better smile.
If my investment thesis proves out, SmileDirect will emerge as the strongest 3D-manufacturing stock over the next several years. Many years ago, Align Technology developed a clear retainer to replace traditional metal braces, but in 2017, its patent for the clear retainer expired, opening the door for SmileDirect to sell generic clear retainers.
As its name implies, SmileDirect uses a direct-to-consumer model. An orthodontist takes an imprint of your bite at one of the company's many Smile Shops, and your clear retainer is made to order. Or the company will send you an impression kit and you can do it at home. In addition to 3D printing, SmileDirect also relies on telehealth. You have virtual visits with the company's orthodontists, who oversee your progress.
SmileDirect's offerings are much cheaper than traditional orthodontics. You can buy a retainer for $89 a month, or pay $1,950 for the whole package compared to traditional orthodontics which can run over $5,000. SmileDirect is expanding the market opportunity with its cheaper and more convenient alternative.
When the market is crashing, buy battleground stocks
Stocks with high short interest can have severe drops in bear markets. This negativity can create a strong buyer's market. Right now, Carvana and SmileDirectClub have a higher than average short interest. If and when the market crashes again, these stocks will be hit particularly hard. And that will be an excellent time for people to buy shares to hold for the long run.