Short interest ratio, the percentage of short shares relative to total amount of floating shares, can have a substantial effect on the performance of stock price in the short run. There has been substantial discussion of the effect of high short interest ratio on the performance of stocks, especially from a contrarian perspective, whereby a high short interest ratio may result in stock price appreciation.
At the same time, we would argue that sometimes a low short interest ratio can both dampen the potential for some stocks, as it can also possibly increase its short term volatility to the downside on negative news.
One such stock with a low short interest is Apple Inc. (AAPL). Apple is one of the top 10 performing stocks in the Nasdaq 100. With a closing price of $544.47 as of 3/1/2012, it is up more than 34.4% year-to-date. Despite such stellar performance, Apple's low short interest ratio could have acted as a drag on its share price in the short run.
As already discussed in our article published on 2/29/2012, "Top 10 Nasdaq 100 Stocks: How Will They Fare For Rest Of 2012?", Apple stock has a very low short interest ratio of about 1.1%. As a matter of a fact, Apple has the lowest such ratio among the top 10 performing stocks in the Nasdaq 100, and according to nasd100.com, such short interest ratio is ranked 88 out of 100 in the Nasdaq 100, where the top ranked stock in short interest is First Solar, Inc. (FSLR),with its short interest ratio standing at 31.8%.
Such a low short interest ratio is a possible indication that investors and traders are impressed with Apple's success and performance, and believe that its shares are not overpriced. Apple's average analyst rating ranking is 2 out of 100, with an average rating value of 1.6 according to nasd100.com, whereby 1 is the highest rating (strong buy) and 5 is the lowest rating (strong sell).
As a result of such low short interest ratio, whenever Apple hits a short term bump, as occurred on 2/15/2012 and 2/29/2012, its shares move violently lower in a very short period of time. Such phenomenon could be influenced by the fact that with so little short interest in Apple shares, there are few traders and investors who are looking to cover their short positions on a price drop. Hence, shares keep dropping until new outright buyers show up.
Apple's low short interest ratio may cause its shares to have volatile short term drops on the announcement of any possible negative news, and may slow the speed in the appreciation of its shares, although from a longer term perspective, such a factor is unlikely to have a lasting effect. As a matter of a fact, we may have already witnessed such phenomenon, as Apple shares were rather slow to shoot substantially higher following the most recent release of its earnings, and it is only recently that they had gained speed in such appreciation.
Apple, Inc. Price Chart
It is no wonder that the opposite is also true, and when examining the top five performing Nasdaq-100 stocks year-to-date, four out of five such stocks have a very high short interest ratio ranging from 17.9% to 34.3%.
Does that mean traders should buy the highest short interest ratio stocks and should sell the lowest short interest ratio stocks? That sounds rather bizarre and counter-intuitive, to buy what you hate and sell what you love.
Not at all, as at the end of the day, it is all about timing, and although such an inverse relationship may hold true for a certain short time span, it may not prove true in the long run. It is very difficult to determine optimum timing. Many traders discovered this the hard way during the last decade, trying to short Internet stocks during the Internet bubble years, and many ultimately getting stopped-out, and losing substantial money, prior to the ultimate burst of the bubble.
In such regard, we can examine three stocks with relatively high short interest ratio, and examine their performance from a longer term perspective.
Sirius XM Radio Inc. (SIRI) currently has a short interest ratio of about 8.2%. Although such short interest is not double digit, it is still quite high. As as matter of a fact, from a historical perspective, SIRI has had a substantially higher short interest ratio than its current levels. A quick look at the SIRI long term price chart shows that it had actually exhibited very high volatility, and at one point lost a substantial amount of its value, losing as much as 95% from its 2000 highs, when it traded around $61, to its current levels of $2.23 as of 3/1/2012, although at one point it had dropped below $0.70.
Sirius XM Radio Inc. Price Chart
Source: Yahoo Finance.
Netflix, Inc. (NFLX) currently has a very high short interest ratio of about 18.4%. Again, although Netflix has performed well year-to-date, its longer term historical performance has been quite volatile, and its current stock price of $112.75 as of 3/1/2012 is substantially lower than its July 2011 highs of over $304.
Netflix Inc. Price Chart
Source: Yahoo Finance.
Research In Motion's (RIMM) current short interest ratio stands at 7.97%. Again, although not a double-digit figure, it is a rather high number. Although RIMM continues to perform poorly, it has somewhat stabilized from its July 2008 high price of $148.13 to its current level of $13.58 as of 3/1/2012. If the previous two stocks of Netflix and Sirius XM are an indication, it is possible that sometime in the future, RIMM shares will see a nice bounce, although it is unlikely they will be near their 2008 highs.
Research In Motion, Limited Price Chart
Source: Yahoo Finance.
There is no question that there are other factors that affect the direction and volatility of share prices, as well as the velocity of price change. For example, in the case of Apple, other factors that could have dampened its price appreciation could include its high share price and its high market capitalization.
Apple's current high share price of over $544 has possibly acted as a psychological perception that it is expensive. Throughout its history, Apple has split its shares only three times, in a 2-1 stock split announcement effective on June 15 1987, June 21 2000, and February 28 2005. It has been more than seven years since Apple's last stock split.
Although it is possible that such factors may not necessarily be a drag on Apple's shares, hence slowing their advance, there is still no doubt that retail investors, who would like to invest less than $500, would not be able to buy Apple shares.
Apple's market capitalization has recently exceeded half a trillion dollars. As of 3/1/2012, Apple's market capitalization stood at $507.65 billion. From a historical perspective, there had been very few companies whose market capitalization had exceeded the $500 billion, and none of the companies' market capitalization is still over $500 billion.
According to the Wall Street Journal, only five other companies have briefly exceeded the $500 billion mark: Microsoft (MSFT) (current market capitalization $271 billion), Cisco Systems (CSCO) (current market capitalization $107.1 billion), General Electric (GE) (current market capitalization $202.3 billion), Exxon Mobil (XOM) (current market capitalization $409.3 billion), and Intel Corporation (INTC) (current market capitalization $134.2 billion).
Traders and investors with long memories will be concerned that if history repeats itself for Apple, as it did for MSFT, GE, CSCO, XOM and INTC, then the odds are stacked against AAPL for its ability to maintain such a market capitalization. Hence, skeptics would bet that Apple shares are likely to drop from their current level, and its potential price appreciation can be dampened.
Although analysts have traditionally focused on the effect of high short interest on the performance of stocks, it is possible that low short interest for well performing companies can both dampen the short term performance of their shares, as it can possibly add to the volatility of downside movement on any unexpected development. Apple can be one such stock, although its lofty share price and high market capitalization could also be additional contributing factors.
Additional disclosure: I may add option positions on some of the discussed stocks in the next 72 hours.