Generally speaking, investors are scared in a bear market. Short sellers use this to their advantage, driving down share prices with selling pressure. But sometimes excessive shorting can backfire, creating a short squeeze as GameStop experienced last year when its shares soared more than 7,000% in a matter of days.
Plant-based food products company Beyond Meat (BYND -3.04%) is one of the most popular stocks among short sellers today. Could it be the next big squeeze candidate? Here is why it might be -- or might not be.
Why Beyond Meat could squeeze the shorts
The company that was a pioneer in bringing plant-based meat products to the mainstream market is currently among the most heavily shorted stocks on Wall Street. A whopping 34% of shares outstanding are sold short.
What does that mean? When you short a stock, you borrow shares to sell, with the obligation to repurchase them later, hopefully at a lower price. If a short seller shorts a stock at $100 and repurchases it later at $80, that $20 spread is the short seller's profit. The chart is showing you that 34% of all the tradeable shares have already been borrowed for short selling. That's a lot!
If many people short a stock and the sentiment around that stock changes, it can create a frenzy of short sellers rushing to buy shares to cover their obligations. The flood of buyers can spike the share price, which is known as a short squeeze.
Beyond Meat is heavily shorted, and a positive catalyst could trigger a short squeeze. The company reports earnings in the first week of August, which could do the trick if operating results are better than anticipated.
Why a short squeeze might not happen
However, it's essential to know that short squeezes are challenging to predict, and trying to anticipate them is a highly speculative and risky strategy. For example, if Beyond Meat reports poor results, the stock could see increased selling pressure and fall further. In other words, a lot of short activity doesn't necessarily mean a squeeze is coming.
For example, investors hoping for a GameStop-like squeeze should note that GameStop had more than 90% of its outstanding shares sold short before it went to the moon. That's an extremely high figure that Beyond Meat doesn't currently come close to, despite being one of the most shorted stocks out there.
Secondly, the company could perform poorly and sentiment around the stock could remain negative; short squeezes often require a positive catalyst to trigger them. Beyond Meat has reportedly struggled to bring satisfactory products to market in its partnerships with Yum! Brands, which owns KFC, Taco Bell, and Pizza Hut.
There is also a legitimate threat of competition from fellow plant-based meat companies like Tattooed Chef and Impossible -- as well as traditional meat companies, such as Hormel Foods, which are pivoting to provide plant-based products.
These are red flags for the company, and are partially why Beyond Meat is being shorted so much in the first place.
An important tip to remember
Short squeezes are intriguing to imagine, but chasing them can be risky business. Never put money at stake that you can't afford to lose. Look at Beyond Meat and keep the company's fundamentals in mind.
Whether a short squeeze happens or not, the business performance and financials will have a much more direct impact on how the stock does over time.