The recent surge in share price seen in Pandora (NYSE:P) begs caution for every investor considering a long position, or even for those who have been long and holding.
Why? Because a run up based on hopes and dreams is exactly what this is. After a sharp drop in share price over the past month, you're looking at a few situations here.
First and foremost, when companies are hit hard by news and a large sell off occurs, there's usually considerable shorting involved. These shorts are typically short term, and will look to cover on an upturn in share price. They're trend followers, day traders, and these guys (and girls) make up a large part of how a stock moves on a day to day basis. With a drop from near $10 per share to a low near $7, these shorts will take their profits when it appears a short term bottom is in.
Second, you have the novice investor. The guy that got stopped out of his position, and the girl that sold in a panic. They have doubts, they second guess, they wait and watch. And they pile in out of hope that they can recover the gains they just lost in short order, as the quick rally brings back their previous bullish sentiment.
Third, you have folks who are chasing news or expecting news to come through the wire. While the first two sets of traders and investors may simply be following the trend, I believe it's this third group who start those trends.
What news might these fresh Pandora investors be expecting? Consider what a commenter wrote in this article here:
"There is a hearing tomorrow before the US house judiciary committee, regarding the Internet Radio Fairness Act, which aims at lowering internet radio royalties to the level of satellite/cable/terrestrial radio (which are all substantially lower, SIRI pays 8% or revenue in royalties, terrestrial radio pays less than 2% of revenue and no performance royalties). This likely justifies yesterday's speculative move as trader's may be anticipating a positive hearing. I however am a little more pessimistic, the Act may gain support, but currently there are bigger fish to fry in Washington. Bold short call as a positive hearing may be a bullish catalyst. "
And I think they have the right perspective here. Qineqt's article suggesting a short certainly is bold, and tomorrow's hearing may very well provide news which confirms Pandora's recent rally and sends the share price back to at least the $10 per share mark. But bold or not, I think Qineqt has the correct play.
I just don't believe there will be any news coming out tomorrow that puts Pandora in a good light. I have to be honest here, Pandora's attempt to fight artists on how much they charge per song holds almost no chance of turning in Pandora's favor. You have to consider the basic idea of the argument here. Pandora is essentially arguing that it can't survive due to the current cost of content, and requesting congressional intervention and a government mandate that artists reduce what they charge for songs so that Pandora may survive.
The problem, though, is not the cost per song. The problem is that Pandora has a broken business model coupled with the fact that Pandora simply can not secure enough advertising to pay for the cost of content. While Pandora does have a subscription option, they do not charge enough for the subscription and given the number of users who make the choice to pay, even at the current low price to subscribe. I would imagine raising the cost is not an option, as users are unwilling to sign up even at current rock bottom prices.
This leaves Pandora in a serious situation. Ramp up advertising to increase revenue at the cost of turning off listeners? Increase subscription costs at the cost of cancellations? Or cry to congress and hope and pray that the government will intervene and force artists to reduce what they charge for their creations.
My suggestion to Pandora executives would be to stop paying yourselves so much money. Look at the millions in stock options insiders bleed from the company on a monthly basis. it's an absolute sea of red since the IPO lockup expired. If Pandora is struggling so very much, why in the world is it awarding those in charge so much money? Take some cues from those insiders. I'd argue that they see the writing on the wall here.
I think this recent rally on what amounts to little more than hope and is ripe for shorting or at least buying short term put options with some of the speculative portion of one's portfolio. In a rally on hope like this, the only positive option is good news, and that news had better be considerably bullish. Bad, or even neutral news could send the share price right back to its recent lows near $7 per share.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in P over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.