One of the largest risks to shorting in a bull market is facing a short squeeze. And one of the better trading opportunities in finding stocks to buy in a bull market is to look for those potential short squeezes.
Admittedly, it doesn’t entirely feel like a bull market at the moment. Stocks aren’t exactly soaring every day. Even the 11-day winning streak posted by the Dow Jones Industrial Average was comprised mostly of middling gains.
But we are at all-time highs in the broad market, and economic indicators are flashing green, as the old saying goes.
Consumers, homebuilders and CEOs alike are more confident. The Federal Reserve is raising rates, seeing enough economic strength to accommodate potentially higher interest expense. It certainly seems as if there could be more room to run in a stock market rally that has lasted the better part of eight years now.
If that’s the case, short sellers could face some pressure, particularly in these three stocks.
Short-Squeeze Stocks to Buy: Wayfair Inc (W)
Wayfair Inc (NYSE:W) might seem like an odd choice for this list, given a still sky-high valuation. And Wayfair isn’t profitable yet, even on an Adjusted EBITDA basis.
Purely from a valuation standpoint, it’s not surprising short sellers have targeted Wayfair. A $3.3 billion market cap for an unprofitable company is always going to draw detractors.
But I’m not sure W stock is all that overvalued to begin with. The stock trades at under 1x sales on an enterprise basis. Direct retail revenue grew a whopping 60% in 2016. The international business is gaining traction as well.
And if you look at results of traditional furniture retailers, like Ethan Allen Interiors Inc. (NYSE:ETH), RH (NYSE:RH) and La-Z-Boy Incorporated (NYSE:LZB), there has been substantial weakness on the top line of late. It’s hard not to draw the conclusion that Wayfair’s $3 billion-plus in revenue is coming from those companies.
Meanwhile, a high-growth, online furniture retailer sounds exactly like the type macro-bullish stock investors would target when looking for stocks to buy. With over 25% of the float sold short, W looks like a classic short squeeze opportunity.
Short-Squeeze Stocks to Buy: Chegg Inc (CHGG)
Part of the issue with Chegg Inc (NYSE:CHGG) is that the market doesn’t entirely understand the story.
Simply looking at the business appears to show a screaming short target. Chegg is modestly profitable on an EBITDA basis, but trades at about 32x that EBITDA and is posting GAAP losses. Meanwhile, revenue declined 16% in 2016.
But revenue figures are colored by a shift in Chegg’s business model. The company has outsourced its textbook rental business, meaning it records only commissions as revenue rather than the full cost of the rental. That shift has freed up cash, and allowed the company to invest in its fast-growing online portal for college and high school students.
CHGG remains a high-risk stock, but there is an intriguing story here, and the potential for industry dominance. Amazon.com, Inc. (NASDAQ:AMZN) often has been rumored as an acquirer for the company. In the meantime, a 21% short float figure and the potential for a strong, seasonally important, first quarter sets CHGG up nicely for a short squeeze.
Short-Squeeze Stocks to Buy: Twilio Inc (TWLO)
Twilio Inc (NYSE:TWLO) stock admittedly got well ahead of itself after its IPO in June of last year. TWLO stock was priced at $15, opened at $24, and closed near $29 on its first day of trading.
By late September, TWLO was above $70. A swift 50%+ decline soon followed, but Twilio stock has settled down since into a range (mostly) between $30 and $35.
Like W, TWLO stock isn’t cheap: the stock trades at almost 7x revenue on an enterprise basis, and Twilio isn’t profitable. But the stock remains a dangerous short, as I argued last month.
Similar high-flying cloud stocks have defied gravity, and burned short sellers, for some time. Workday Inc (NYSE:WDAY) trades at 10x revenue. Shorts have been targeting Veeva Systems Inc (NYSE:VEEV) for some time, and that stock is up ~150% since last January, and trades at an all-time high.
Twilio has a huge opportunity in cloud communications, and as long as revenue growth cooperates, TWLO’s valuation can stay elevated. And if that growth comes, and the broad market continues to rise, it seems likely a short squeeze of the 29% short float will follow.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.