As Nokia's (NOK) turnaround efforts continue, many short sellers are betting their money on the failure of the company. As of right now, short interest for the Nokia stock is at all time high. Last summer, when the share price of Nokia fell to as low as $1.70, many people saw the bottom in the company and bought a bunch of the company's shares. This, along with short covering, helped the company's share price to recover to levels above $4. In the last few weeks, Nokia's share price has been underperforming the market and this was most likely a result of heavy shorting.
When a company's shares are heavily shorted, this leads a lot of people to panicking. People usually think "those who shorted this company might be on to something" even though shorts tend to lose money more often than they earn money in the long term. There is always a perception that "short sellers" are more intelligent than "long holders" because they take bigger risks, therefore they must have better calculating skills. Of course, perception is not always reality. While the short sellers that make money will be a lot more intelligent than short sellers that lose money, they are rare and far between. In fact, there is little if any correlation between trading styles and intelligence. Some of the most successful investors in the history employed "buy and hold" as their strategy, while others used other strategies as well.
In general, if I'm holding a company that is heavily shorted, this doesn't scare me as long as I still believe in the company. In fact, it makes me happy. The fact is, every short seller has to cover his or her short position sooner or later. It's only a matter of time before a shorter has to cover his or her position, which means there will be as many buyers of a stock as there are short sellers. If a company was short sold by 10 million people, it means the company will have 10 million buyers in addition to the people who believe in the company at the moment. Currently, 337 million Nokia shares are shorted, which means these shares will be covered sooner or later. Given that Nokia has about 3.7 billion outstanding shares, we can say that 9% of all Nokia shares are shorted. Currently, Nokia's average daily volume is around 45 million, which means if all short sellers decided to cover their positions around the same time, this behavior alone would lead to a rally of 7-8 business days for the company's share price. The chart below shows the amount of Nokia shares shorted by date.
Since summer, more short sellers jumped into the Nokia train because of a belief that Nokia was "pumped up" by hopeful investors after hitting $1.70. Even today, a lot of people believe that Nokia's run from $1.70 per share to $4.50 per share was without a basis and it would reverse sooner or later. In fact, some of the gains in last summer's rally were already erased because of heavy shorting, profit taking and some other factors, but this doesn't mean that the rally of last summer was without a basis. When Nokia was priced at $1.70, the company was priced below its book value. More specifically, the company's cash reserve alone was worth around $3.50 per share when the company was trading for $1.70. When a company trades below its book value, this means that the company is priced for bankruptcy. If a company is seen as a profitable one by the investors, it will trade above its book value. So when Nokia was priced for bankruptcy back in the summer, it was natural for the share price to see a rally once the investors realize that Nokia is here to stay. This is exactly what happened. Currently, very few investors actually see Nokia going out of business anytime soon; whereas, last summer, many investors and analysts were so sure that Nokia would not exist for much longer. Obviously, when investors see that Nokia is not likely to go out of business anytime soon, this will add to the valuation of the company. Even if a company barely sees breakeven, it should not trade for values below its book value.
Of course I am not saying that Nokia is risk-free. There is no such thing in the investment world. Every investment has a risk-reward ratio, and risk is usually positively correlated with potential rewards. Nokia's turnaround is still not complete and the company might continue to lose market share in a number of countries due to either demand or supply issues. While the company's newest Lumia phones are comparable to the phones of the competition in terms of quality and usefulness, the competition is also evolving quickly. Companies in the technology sector have to keep innovating almost non-stop in order to keep up with the current trends. In 2013, Nokia isn't expected earn or lose much money. Most analysts expect Nokia to either post a small profit or a small loss with the average estimate being a profit of 1 cent per share. Keep in mind that Nokia has beat the analyst estimates in the last few quarters and it might happen again; however, the important point is that Nokia is very likely to survive all this turmoil and move forward as a new company. At this point, I would treat Nokia as a start-up company, because Nokia is a born-again company. In order to reach its goal of having a global market share of 10% in the smart phone market, Nokia will have to grow like a start-up company anyways. Even the most pessimistic analysts expect Nokia to increase the number of Lumias sold by more than triple by 2015.
Nokia will not be paying a dividend this year; however, you can create your own dividends by selling options on this highly volatile stock. By doing that, I am able to bring down my breakeven price further each month. I am still holding onto my Nokia shares and I am hoping to add more if the share price falls below $3.00.