Last year, the uncertainties surrounding the unprecedented coronavirus disease 2019 (COVID-19) pandemic whipsawed the stock market. Unfortunately, changing the calendar to a new year hasn't meant putting volatility in the rearview mirror.
Instead of COVID-19 dominating the headlines, it's retail investors that have been the driving force behind a lot of the volatility we've witnessed in 2021.
Retail investors are targeting heavily short-sold stocks
Retail investors on Reddit's WallStreetBets (WSB) chatroom have effectively banded together to buy shares and out-of-the-money call options on heavily short-sold stocks. Short-selling involves borrowing money from a brokerage to bet against a stock. In other words, short-sellers make money if the share price of a stock declines. The thing about short-selling is that gains are capped at 100% (a stock can't fall below $0), whereas losses are unlimited.
The WSB community has specifically focused on companies with high levels of short interest, with the hope of creating a short squeeze. In simple terms, this is where pessimists all rush for the exit at once. Since exiting a short position involves buying stock, a short squeeze only exacerbates a stock's upside move. Although retail investors are able to short-sell, the short positions being targeted by the Reddit traders are primarily held by hedge funds and institutional investors (i.e., the big money).
The wild swings we've witnessed in heavily short-sold equities have been especially attractive to Robinhood's millennial and novice investors. Of the 100 most-held stocks on the platform, 31 have at least 10% of their shares held short relative to float.
Short-sellers have piled into these Robinhood stocks
However, the following 10 Robinhood stocks are the most short-sold (as a percentage of float) on the entire platform in March, according to data provided by Finviz.
- Rocket Companies: 38.1% of float held short
- Blink Charging (BLNK 10.31%): 36.3%
- GameStop (GME 6.81%): 30.4%
- Senseonics Holdings: 28.3%
- Nano Dimension: 28%
- fuboTV: 27.9%
- TherapeuticsMD: 27.3%
- Inovio Pharmaceuticals (INO 13.71%): 25.8%
- Sundial Growers (SNDL -1.99%): 24.4%
- Castor Maritime: 23.7%
Penny stocks are dangerous for all parties
If there's one thing that stands out from this list, it's that short-sellers and millennial investors love to play tug-of-war with penny stocks. TherapeuticsMD, Sundial Growers, and Castor Maritime are hovering around the $1 a share mark, while Nano Dimension, Inovio, and Senseonics were all penny stocks at one point within the past 12 months.
Generally speaking, penny stocks are priced low for a reason. They often have unproven business model and/or are losing money. Though not all penny stocks are worth avoiding, caution is warranted more often than not.
Canadian marijuana stock Sundial Growers, which I'm not shy about disliking, has drowned its existing investors in new share issuances over the past five months. Although it's raised over $600 million in cash, the company has also issued over 1.1 billion new shares. With approximately 1.66 billion shares outstanding (this figure includes the recent warrant exercising of 98.3 million shares), Sundial has little chance to produce meaningful per-share profits.
At the same time, short-selling penny stocks is highly dangerous. Even if there looks to be a surefire bearish case, such as with Sundial, the market can remain irrational for weeks or months at a time. If momentum investors lock in on a penny stock, a short squeeze could exacerbate this euphoria.
Pessimists have a point
The other thing worth pointing out about Robinhood's 10 most short-sold stocks is that pessimists are potentially right about the vast majority of these companies (penny stocks or not).
For example, electric vehicle (EV) charging equipment and EV station operator Blink Charging has lost more than half of its value over the past month, yet still sported a $1.25 billion market cap, as of this past weekend. Even with EVs representing the future of the automotive industry, Blink generated only $3.8 million in sales through the first nine months of 2020. It's unclear how Blink's products and services will differentiate themselves from an increasingly crowded field of ancillary EV players.
There's also clinical-stage drug developer Inovio Pharmaceuticals, which over four decades has yet to bring a U.S. Food and Drug Administration-approved therapy to market. Inovio generated a lot of buzz last year by tossing its hat into the COVID-19 vaccine development arena. However, the company's phase 2/3 study was placed on partial clinical hold in September. Despite being able to commence with mid-stage studies, Inovio's late-stage trial remains on hold.
And then there's GameStop, which essentially started the Reddit frenzy in January. Despite reporting 309% growth from e-commerce sales during the holiday season, GameStop's total sales still declined by 3.1% as its store base fell by 11% from the prior-year period. GameStop waited far too long to switch its operating model to a digital focus, and now the company is scrambling to get back into the profit column by shuttering a number of its physical locations.
In other words, there's often a very good reason behind a stock's high short interest.