This year's hottest IPO finally cooled off. Shares of Shake Shack (NYSE:SHAK) slumped 11% last week -- and opened lower to kick off this week -- but let's not call this a crash. It's not.
For starters, the stock has soared 294% since going public at $21 less than five months ago, even with last week's slide. All last week did was take us from "more than quadrupled" in price to "nearly quadrupled" when it comes to describing the gourmet burger chain's spectacular rookie year as a public company. You won't find too many longs licking their wounds after last week's retreat.
There's also no point in trying to smoke out the news that led to the step back. That search would be as fruitless as trying to determine the reason for the stock's 34% surge a week earlier. The only material development that surfaced during the prior's week's pop was a report that Shake Shack had taken out a Chicken Shack trademark. The chatter quickly fueled thoughts of a sister concept specializing in poultry. However, that certainly doesn't seem like a bonafide reason for an already dearly priced stock to expand its market cap by more than a third.
There's really only one reason for Shake Shack's volatility, and it boils down to the impact of heavy shorting activity on its stock. Like most IPOs, only a handful of the total outstanding shares are made available to the public. This results in a small float, which clocks in at 5.9 million shares, according to S&P Capital IQ data. That's a sliver of the more than 36 million shares outstanding across both classes of stock. Shake Shack had 2.2 million shares sold short as of the middle of May. That might seem like a small number of bearish wagers, but it represents more than a third of restaurant chain's public float. That's a pretty big deal. It makes a short squeeze -- when naysayers scramble to cover their positions at the first whiff of a rally -- that much more likely.
Is Shake Shack overvalued? You bet. It began the week packing a $3 billion market cap. You won't find too many eateries fetching 23 times trailing sales. Some bears tried to paint a gloomy picture, dividing Shake Shack's market cap by its 66 restaurants to arrive at the grim nugget that investors are paying nearly $50 million for each location.
It's actually worse than that. Just a little more than half of its locations are owned by the company, putting the valuation of company-owned locations closer to $100 million.
None of this means Shake Shack is destined to crumble. The company has plenty of expansion space, and we still don't know if it will be able to grow a sister concept. However, more importantly, as long as so much of Shake Shack's float is in play on the short side there will always be opportunities for short squeeze rallies. So, yes, Shake Shack took a breather last week. It doesn't mean hibernation awaits.
Shorts will never be comfortable betting against Shake Shack, and that opens the doors for rallies despite the lofty valuation. This could all change when the lockup expiration ends this summer, giving insiders with ridiculously appreciated shares a way out that would likely pump up the float. Shake Shack also could stage a secondary offering to gain more financial leverage. Until these things happen, Shake Shack will be a dangerous but juicy short.
Rick Munarriz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.