It’s been a wild ride for Co-Diagnostics (NASDAQ:CODX) stock this year. Shares are up more than 1,800% year to date, and with a ton of volatility and drama along the way.
The novel coronavirus has given the company a massive catalyst but also caused a great deal of controversy around the company. The company’s Covid-19 test could generate a ton of revenue, but skeptics wonder if it is reliable enough to be the go-to solution at this point.
While the scientific debate will rage on in the months ahead, there’s a more pressing matter coming up for traders next week. Co-Diagnostics will be joining a major stock market index. This, in turn, should cause a lot of buying pressure, leading to above average trading volume and potentially a move in the share price in coming days.
CODX Stock Joins the Russell 2000
You might be wondering why it’s so important when a company like Co-Diagnostics joins a major stock index. Recent data suggests that $9 trillion of investor dollars are in funds that use the Russell indexes as a benchmark their own performance. Fund managers will now have to consider Co-Diagnostics and other new index entrants to make sure their funds don’t underperform the industry standard for smaller capitalization companies.
More specifically, around $1 trillion is in passive funds that directly track the Russell indexes. The Russell 2000 is, by far, the most widely followed of these indexes. Thus, with Co-Diagnostics soon joining this prestigious list, it will attract a sizable flow of funds that are compelled to invest in all 2,000 companies that make up the index.
Momentum Traders’ Paradise
For years, there has been evidence that when companies enter the Russell 2000, it has a material impact on share prices and trading volume. It’s not uncommon to see companies, particularly small under-the-radar ones, move up 10% or more in the days and weeks ahead of index inclusion.
Thus, some traders have started to specialize in making a profit from this opportunity. The Russell announces their index membership changes in May, but they don’t go into effect until June. This gives exchange traded funds and other such vehicles time to move in and out of positions. Traders can ride along with that momentum, buying into shares that are set to be added to the index.
Co-Diagnostics’ Fundamental Debate
Of course, there’s more to consider than just a short-term technical factor. As for the company’s business itself, there’s been a great deal of debate about the commercial viability of Co-Diagnostics’ products. In particular, its Covid-19 test has sparked controversy.
On the bull side, for example, InvestorPlace’s Mark Hake worked through the math around the test kits. Using some reasonable assumptions about pricing, Hake concluded that Co-Diagnostics’ current valuation seems justified and that shares could reasonably double or triple if things run ahead of expectations.
Not everyone agrees, however. Short sellers have taken a massive stake betting against CODX stock. And there have been numerous newspaper articles questioning the efficacy of the company’s tests.
The mood has gotten so vitriolic that one firm is seeking to bring a lawsuit against Co-Diagnostics. Gelt Trading claims that it was misled by inaccurate claims about the inefficacy of Co-Diagnostics’ tests. Further, it bluntly accused management of executing a “pump and dump” scheme. So far, that lawsuit threat hasn’t affected the share price much, but it shows the stark level of controversy around Co-Diagnostics.
Co-Diagnostics’ Bottom Line
From a purely fundamental basis, the skeptics make some good points. Co-Diagnostics is a small player in a huge market. Historically, the track record of firms like Co-Diagnostics isn’t great in these sorts of situations. Throw in the questions around this particular Covid-19 test, and there is reason for caution on Co-Diagnostics as a long-term investment.
In the short-term, however, for risk-seeking traders, there could be a decent swing trade opportunity heading into the Russell 2000 inclusion. The index changes are set to go into effect on June 26. This potentially gives Co-Diagnostics less than a week to enjoy a run-up.
Do note, however, that this momentum play could head sharply into reverse later this summer. Once the index shake-up is complete, the ETFs won’t have to buy more Co-Diagnostics stock. At that point, Co-Diagnostics’ uncertain fundamental outlook will once again take center stage.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek. At the time of this writing, he held no positions in any of the aforementioned securities.