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Let's get this out of the way. We are Sirius XM (NASDAQ:SIRI) bulls-- so much so that we listed SIRI among 5 Stocks That Could Double in Price. But the following article is as impartial as possible, with a focus on a structural factor that should boost the company's stock price. Does this factor guarantee future upside? NO. This is a positive factor for the stock, but it is by no means a guarantee because other negative variables could outweigh the positive aspects of the short interest effect.

Sirius XM Radio's stock price has dropped substantially in the last few weeks. While much of this is related to the broad market weakness across all industries, much of it is specific to SIRI. Fundamentals have not changed during this decline in the stock price. The company recently released earnings and management is generally tight lipped between earnings releases.

The major shift has come from sentiment. The stock market is concerned about a slowing economy, and as a result, higher beta names are getting hurt. In addition, Pandora Media (NYSE:P)'s recent IPO is causing concern, not necessarily because of concrete competitive factors but because of the general uncertainty. For example, Pandora's IPO only draws attention to the stock, but it does not make it a more competitive threat to SIRI than it was a few weeks ago before the IPO headlines started. The headlines have only changed the market's perception of the threat but not the competitive threat itself. The IPO has only stirred old Pandora headlines about the company's rapid growth of popularity on mobile devices and recent partnerships with automobile manufacturers.


STOCK DECLINE
SIRI's stock is down substantially in a short period of time. The stock peaked at $2.44 intraday on May 31, and recently traded as low as $1.86 intraday. The move lower has been accompanied by occasionally high volume, but this has not been exclusively the case. The degree of the decline is not perfectly correlated with the magnitude of the volume traded. As such, it is reasonable to believe that once a sentiment shift occurs, even a marginal increase in share demand could have an outsized effect on the stock price.

DateDay's ChangeTraded VolumeAvg Volume (3m)
June 13, 2011-$0.09169,235,20079,482,000
June 10, 2011-$0.0882,199,70079,482,000
June 9, 2011+$0.0564,383,40079,482,000
June 1, 2011-$0.0891,400,10079,482,000


For example, June 13th, June 9th and June 1st featured similar stock price declines, but June 13th required nearly double the average volume to drive the price down that magnitude, while on the other days, the stock fell on average daily volume.


SHORT INTEREST RISES
According to data from Nasdaq.com, short sellers have really hounded SIRI shares. This has undoubtedly pressured the stock price. When an entity initiates a short position, they are selling shares borrowed from someone with an existing long with the promise that they will repay those shares at a future time. But regardless of the borrowing dynamics, the near term effect on the stock price is the same as any other sale.

SIRI's short interest has not declined since mid February. In May alone, short interest soared from 278,421,342 shares to 317,089,214 shares. This 38,667,872 share increase is substantial, but there isn't a straight forward way to predict the effect of this marginal future stock demand. Based on our trade data from June 1st, 9th and 10th, it may be tempting to approximate that the ~38 million shares worth of demand could produce a ~$0.03 increase in the stock price. But not only is this too small of a sample to draw concrete conclusions, this approximation likely underestimates the effect of this short interest demand, since the short interest shares are marginal demand, so they will have an outsized effect holding other market factors constant. The main takeaway is that while the magnitude is unclear, the directional effect is. The same short sellers that have pressured the stock over the last few weeks will have a positive effect on the stock price in the future. The guaranteed future buying among short sellers could add fuel to a serious stock rally.


SETUP FOR STOCK PRICE UPSIDE
Technically driven price action can persist in the near term, but after a long enough period of time, fundamentals take over. As the stock price declines, the stock fundamentals become cheaper for potential shareholders.

Short sellers have a negative effect on the stock price at the time of the short sale and a positive effect sometime thereafter because they are guaranteed purchasers of the shares at some time in the future. When short interest increases as stock price declines, this is evidence that the company is victim to extreme sentiment. Any change in this sentiment can fuel the stock and compliment the positive upside from short sellers covering their positions.

If you are bearish of SIRI, make sure you are doing so for the right reasons. For example, maybe you are fundamentally pessimistic about the company's competitive situation relative to Pandora Media (P) or you are concerned about the slowing economy's adverse effects on global automobile demand. But don't panic and build your bear thesis on the fact that all of the other short sellers hate the stock. This would be a major mistake.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SIRI, P over the next 72 hours.

Source: Sirius XM's Recent Weakness Sets Up Big Stock Rally