Whether you're a new investor or have been putting your money to work in the market for decades, there's always something new to see.
Last year, it was the once-in-a-century crash and epic rebound tied to the coronavirus pandemic. In 2021, it's all about the perceived power of retail investors.
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Short squeezes take center stage
Short-sellers are investors who borrow money on margin to bet against a security. They make money if it declines in value, with gains capped at 100% (a stock's share price can't drop below $0), while losses are unlimited. A majority of the outstanding short interest in the market comes from institutional investors and hedge funds.
Beginning in mid-January, retail investors on Reddit's WallStreetBets (WSB) chatroom began banding together to buy shares and out-of-the-money call options in stocks with very high levels of short interest relative to their float (i.e., the tradable number of shares). The goal for these WSB traders has been to enact a short squeeze.
In simple terms, a short squeeze is an event where short-sellers become trapped in their positions. A rapidly rising share price gives them cause to exit, sending them scurrying to cover their positions at the same time. Since covering a short position requires buying shares of the company in question, it only exacerbates an upside move.
Since mid-January, we've witnessed a number of successful short squeezes. The most popular of these have been in movie-theater operator AMC Entertainment (AMC 8.23%), video game and accessories retailer GameStop (GME -3.94%), and Canadian marijuana stock Sundial Growers (SNDL 0.54%). On a year-to-date basis through March 29, AMC, GameStop, and Sundial had advanced by 388%, 864%, and 137%, respectively.
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Another squeeze is highly unlikely for AMC, GameStop, and Sundial Growers
However, many young and/or novice investors buying into AMC, GameStop, and Sundial today believe that another round of short squeezes are coming, which could offer even more upside than the initial round of short squeezes in these stocks. To these investors, I have some bad news: It's highly unlikely.
There are two variables to a short squeeze that are incredibly important. First of all, a high short interest is paramount to the success of a short squeeze. The higher the percentage of shares held short relative to the float, the more likely it is that pessimists will be trapped in their positions.
Back in mid-January, GameStop's short interest was the highest on Wall Street at over 100%. But as of March 15, 2021, only 10.2 million shares of GameStop were held short. That's down from around 50 million two months prior.
Likewise, AMC and Sundial now have short interest of 12% and 10%, respectively. These are high percentages relative to the average publicly traded stock, but not eye-popping in the sense of effecting a short squeeze.
Secondly, and arguably the bigger issue, is that there's been a significant decline in what's known as "days to cover," also known as the short ratio. This is a measurement of how many days it would take all short-sellers to cover their shares, and it's based on a stock's average daily trading volume.
For example, when GameStop had in the neighborhood of 50 million shares held short and an average daily trading volume of around 6 million shares, it would have taken eight sessions for short-sellers to cover their positions. That's the definition of trapping a pessimist in their position.
Unfortunately, the days-to-cover figure isn't all that impressive anymore. As of March 15, 2021, GameStop's, AMC's, and Sundial's short shares could all be covered in a matter of a few hours. With GameStop, AMC, and Sundial respectively averaging 45.1 million, 175.2 million, and 546.9 million shares traded daily, there's zero urgency on the part of pessimists that they're going to get trapped.
Image source: Getty Images.
There's a bigger worry here
With the primary catalyst for all three of these Reddit stocks tossed out the window, their operating miscues and/or balance-sheet flaws stand out like a sore thumb.
For example, AMC Entertainment's operating model has been completely disrupted by the pandemic. Some streaming services are planning to release films at the same they're slated to hit movie theaters in 2021, which could crush the company's chances of a turnaround. But the bigger issue here is AMC's crippling debt load, some of which is sporting interest rates ranging from 10% to as high as 17% (variable).
AMC's ongoing losses are likely to eat up whatever remaining cash the company does have over the next 12 to 18 months. Without additional dilutive offerings, I don't see how AMC survives.
Things are a bit brighter for GameStop in the sense that bankruptcy isn't on the table. Nevertheless, this is a company that leaned on its brick-and-mortar operating model for too long. With digital gaming dominating play these days, GameStop has been scrambling to close its physical stores in an effort to reduce its operating losses. Even though e-commerce sales jumped 191% last year, total sales for the company declined by 21%.
As for Sundial Growers, we're talking about a company with a boatload of cash -- $719 million Canadian ($570 million U.S.) and no debt -- that built up its war chest by issuing over 1.15 billion shares of stock in just five months. This level of share-based dilution is some of the worst I've ever seen. To make matters worse, Sundial's management doesn't exactly have a plan for its cash, and the company is one of the slowest-growing pot stocks in the industry.
With sustained short squeezes off the table, AMC, GameStop, and Sundial are nothing more than speculative dart throws -- and not very good ones, at that.
