SodaStream (NASDAQ:SODA), which develops beverage machines for consumers, just posted a bubbly earnings report that showed profits surging 84% to $10.1 million, or 48 cents per share.
SODA shares exploded on the news, up 25% in Wednesday trading. But investors should be cautious, as it looks like most of the move has come off the strength of a classic short squeeze.
A short squeeze is when short sellers “cover” their positions to avoid major losses; to do this, they have to buy back stock, which fuels even more demand.
As you’d imagine, this can be extremely painful for the short sellers.
In SodaStream’s case, about 85% of the stock’s float was short — an unusually high level — so the spike in SODA shares should come as no surprise. However, even with many of the shorts scared away, it still would be dangerous for investors to jump into SODA right now.
First of all, SodaStream remains a broken growth story. The company has been trading mostly in a range between $30 and $40 since losing more than half its value last August.
SodaStream’s products also are discretionary — heck, they’re niche — and could face some headwinds over the next year. Western Europe is a major source of revenues, and the company also has been investing aggressively in the U.S., which itself is showing signs of another slowdown. As seen with similar companies — like Green Mountain Coffee Roasters (NASDAQ:GMCR) — a small change in consumer sentiment can be detrimental to sales.
Even if things improve and SodaStream is back on the mend, investors still should remember their discipline. Buying a stock when there is a short squeeze is usually a losing trade.
Just look at Sears Holdings (NASDAQ:SHLD). InvestorPlace editor Jeff Reeves recently discussed how the shorts were piling on Sears early in the year (with a short interest of about 10 million shares, or 50% of the float). When Sears had a decent earnings report, the stock naturally spiked from $30 to a high of $83.
Unfortunately, many investors put too much confidence in the run portending to better things ahead and bought into SHLD near that top. That ended up being a pretty bad move: In less than two months, Sears stock has fallen to $54.
In other words, the run caused by a short squeeze usually is just temporary; it’s really artificial demand and not a sign that a company is winning back Wall Street.
So before buying a stock that has gapped up, make sure to check out the stock’s short interest from before the move. If it is more than 10% of the float, then it’s a good bet the stock is enjoying a short squeeze. The best approach then is to wait a couple months until things calm down, the valuation is more reasonable and more shorts have subsided.
Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook”, “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.