The stock market is based on the very simple principle of supply and demand. When demand is higher than supply, a stock typically goes up, and when supply is higher than demand, a stock price goes down. One interesting aspect to the stock market is the ability to short shares. This allows investors to actually sell shares in a company they don't own with the intent to replace those shares at a lower price. This is all done on margin and is risky since the theoretical loss limit is infinite if the stock goes up and the investor cannot buy those shares back. Shorting is a well accepted strategy in today's market, but eventually the shares need to be replaced. In the case of some stocks that have a large short position relative to the actual float, a short squeeze can happen. A short squeeze is basically the inability of investors to cover their short positions without causing the stock to move up.
There are certain industry criteria that investors looking for short squeeze candidates screen for.
Number of shares that are shorted. This data is published twice a month going back many months and can be found on several sites. This data not only shows the current number of shares shorted but also the trend if the position is getting larger or smaller.
Days to cover. This metric takes the average volume and divides the number of shares shorted by it. This tells how many days it would take to cover a short position. For example, if there were 1 million shares shorted and 100K/day of volume, it would take 10 days to cover meaning all trading for the next 10 days would be buys. This would cause any stock to rocket upward. In my opinion, any number over 5 days to cover is significant.
Shares shorted versus float. This metric looks at the number of shares that are reported short versus the reported float. If this number is high, it is not hard to imagine that the short squeeze potential is significant as trying to repurchase those few shares that are available could cause the stock to rise.
Shares shorted versus real float. A more significant metric that looks at the number of shares shorted versus the real float. The real float looks at all the SEC filings, institutional holdings and investor 13Gs to try and determine how many shares are really in the float. This number is much more significant if the real float is much smaller than the reported float, and therefore, it really is much harder to replace the borrowed shares without a significant run up in share price. If the shares shorted are over 50% of the real float, there exists a high probability of a short squeeze, and in recent years, there have been some unbelievable moonshots of stocks whose small float became an investor's dream when stocks have risen 10X in a small space of time.
While all these indicators are used by investors looking for short squeeze candidates, it should be apparent that fundamentals have nothing to do with a short squeeze. It is all based on the simple principal of supply and demand, with the supply being restricted to the point that any demand causes a significant pop in share price. Some examples of stocks in the last year that may have been short squeeze stocks include: Wins Finance (NASDAQ:WINS), 733K float, yearly range $10 to $465, and GRAVITY (NASDAQ:GRVY), 1.4M in float, yearly range $4 to $39.
Whether these were entirely short squeezes or not, they all had the characteristic of shorted shares and very low floats that were extremely tightly held.
Now that I have gone through some of the key metrics that I look for when trying to identify a potential short squeeze candidate, I will analyze a company that I have been buying and will continue buying shares in called Professional Diversity Network (NASDAQ: IPDN). There are two sites I use to collect data on the number of shares that are short, days to cover and what they believe is the float. These sites can be found here and here.
Shares shorted. On both sites, the number of shares shorted as of 5/15/2017 is 223K. There is also a trend of the number of shares shorted going up from 179K on 4/13 to the 223K that was just reported.
Days to cover. As the reported average volume is around 22K shares/day, the days to cover is around 10 days. This means if a short was forced to cover, i.e., a short squeeze started, then they would need to buy every share available for the next 10 straight days. This is significant and impossible to do without causing a rocket ship type launch in share price.
Shares shorted versus float. With the float being reported at 846K and the shares shorted being around 223K, the percentage of shares shorted to reported float is over 25%. This is a very high number and also a very small float.
Shares shorted versus real float. This is really the key metric to determine the potential for a short squeeze. Reviewing all the SEC filings over the last 6 months, the chart below was developed. After subtracting out all the insider holding, institutional holdings and recent large shareholder 13G filings, the real float is 192K shares. Given the 223K shares reported short, this would lead to the conclusion that a massive short squeeze could occur since the shorts would be unable to repurchase enough shares to cover and the price would go through the roof. While this may not happen, it is a perfect illustration of the risks involved with shorting a low float stock.
|Shares outstanding as of May 11th, 2017||3,934,617|
|Directors and Insiders Sch 14F-1 10/26||373000|
|Daniel Ladurini sch 14f-1 10/26||286,000|
|Mathew Proman sch 14f-1 10/26||205,000|
|Institutional holdings as of 3/31/2017|
|North Star Investment||77,000|
|White Winston as of 2/13/2017 424B3 filing||125,000|
|Ahmed Alomari 13G on 5/18/2017||286,000|
|Total Closely Held shares||3,742,300|
|Total Real Float||192,317|
|Shares Short as of 5/15/2017||223,000|
Real Share Float data calculated using SEC filings
While all the metrics indicate that a short squeeze is possible, there still is the question of why is there such a large short position to start with and also what type of catalysts could actually start a short squeeze. It is not hard to see why the stock is being shorted. The fundamentals have been deteriorating for a while. Revenues have been declining in their core business and they have been retooling the NAPW segment which has been generating unprofitable revenues. Losses continued to be high as they are restructuring and transforming the US based business and launching in China. Since the company is shooting for profitability in mid-2108 at this point, the investors who are short have seen no reason to cover. There also has been some promotion in the stock with various newsletters picking up coverage. This may be due to some larger investors trying to generate more interest in the stock since volume has remained low at about 20K shares per day.
In order for a short squeeze to occur, some type of catalyst is required to start the short covering. One of these catalysts could be the purchasing of shares by insiders or additional purchases by a large outside investor. Both of these have occurred in the last few weeks as Executive Chairman James Kirsch purchased shares on the open market last week and investor Ahmed Alomari filed a new 13G raising his holdings to 286K from 245K. If these trends continue, there will be much fewer shares than 192K that were calculated as the real float. Either way, it is a very bullish sign that insiders and large independent shareholders continue to buy shares.
Another potential catalyst could be a turnaround in financial performance. With only 4 million shares outstanding, zero debt, and in the recent 10-Q an indication they would not need to raise money in the next 12 months, the company is in better financial position than it has been in the last 2 years. New management, from China, who have invested in the company at valuations at the time over the market value, have a plan to not only turn around the US based business but enter the China market that is untapped in this area. Taking a deeper dive into the latest 10-Q, the results are not as bad as many thought. Three out of four of their divisions actually reported positive revenue growth in the quarter, with the only declining division being the one they have intentionally planned to reduce costs in. The China division launched with just one event in China during Q1 and that generated $324K in revenue. So far in Q2, three events have already been staged and 20 more events are planned during the remainder of the fiscal year. The events are only the start of revenue generation in China as they tie to the other businesses within the company such as the anticipated launch of the China based woman's networking business that is set for this summer and the international education support business that launches later this year. To put it in perspective on the potential of business in China, keep in mind the very first event ever in China drew 2,300 paying participants and $324K in revenue. Chinese woman account for over half of the college graduates in China these days and they are the second most in terms of population on this planet. This untapped market should see significant revenue growth and seems likely to grow very quickly with 20 additional events planned over the course of the next 6 months.
While short squeezes are impossible to predict, they do happen. The characteristics of a high number of shares shorted versus how many shares are really available to trade are a key indicator to the probability of it happening. Low float stocks also have a tendency to move in extreme ways either up or down because of the illiquidity in their shares. Typically, there are some unforeseen catalysts that cause the investors who are short to try and cover before the stock goes parabolic. One of these catalysts could be the continued buying of shares on the open market by management. There is no better indicator of management bullishness on their own stock than buying shares.
Disclosure: I am/we are long IPDN.
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.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.