Dreamworks: Are Shorts Facing A Squeeze?

| About: Dreamworks Animation (DWA)

Dreamworks (NASDAQ:DWA) share price has taken a pounding for several months but has bumped up strong the last two weeks and stands now at a 30-day high.

DWA Chart

DWA data by YCharts

This has come at a Dreamworks slide from a 2010 high above $42 as the box office return on the animator's new release movies have disappointed. Earnings are down and therefore so is the price.

Short sellers noticed and piled on. As of Friday, September 14 the raw short sale ratio stands at a hefty 25.7%, while the short ratio to the float is an eye-popping 44.2%. This is a slight increase from a 40.22% short float in July. Short Sellers have made a killing the last two months but the rebound may be in sight. A run up in Dreamworks price has the potential of causing a Short Squeeze.

For the uninitiated, short sellers sell borrowed stock with the expectation that the share price will drop. They plan to buy shares later at a cheaper price to cover their position. If everything works as they expect, the stock price goes down, they will be in line for some juicy profits. However if prices go up they end up with a loss, maybe a big one.

Several positive news items have been building up, causing some positive buzz which expects Dreamworks to ramp up earnings:

The Dreamworks movie Madagascar 3 was a huge hit this summer, bringing in worldwide box office sales of $1.3 billion to date, plus expectations of large merchandising numbers, and the company should report huge earning pops in 3Q and 4Q 2012. Take a look at an earnings to price chart for Dreamworks:

DWA Chart

DWA data by YCharts

Share price typically explodes before announced earnings based on the successes of Dreamwork's box office hits. And the animators are overdue for a big hit like the numbers churning out from Madagascar 3.

Additionally, Dreamworks has announced they are ramping up movie production. For years the company was making two movies a year. Later it raised this to five movies every two years. Now it has announced it will be producing and releasing three movies a year. That is a 20% production growth which should have a massive impact on the bottom line.

Add that to the market upswell from the Fed's announcement of QE-Infinity and you have a lot of positive force putting some wind under Dreamworks' wings.

Additionally the company has announced plans to develop a theme park in China as well as a new television channel. These are long term projects, although admittedly these could dampen earnings near future while Dreamworks makes the early-stage investments.

Since a lot of shorts have already made money off Dreamworks, the spate of positive news coupled with the uptick in stock price is likely to tempt some shorters to close out their positions and take their profits. This could make the Dreamworks price spike upward, causing more shorts to head for the exits and within hours we could have 42% of the float being bought.

I'll be looking at how the price and volume numbers develop on Monday. After the run up this last week, it wouldn't be unusual for a pullback as investors consolidate their positions. However, if the stock continues its run up, especially with higher volumes, then short sellers may soon feel the pinch and start to hit the exits. If even 10% of the shorts start to bail, it could start a chain reaction and the stock might leap forward.

Granted, that's a lot of maybe and mights. Just watch the early numbers Monday and we will see what happens. This next week could be spectacular in Dreamworks stock if a short squeeze does develop.

Disclosure: I am long DWA. 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.