If you’re looking for some explosive returns in the stock market, you might want to consider betting on short-squeeze stocks. These stocks have a high percentage of their float sold short by hedge funds and other bearish investors betting on their decline. However, if the underlying businesses get even some slightly positive news, their stock prices can rally and deliver multi-bagger gains as bears would have to continuously cover their positions. This creates a positive feedback loop that can drive the stock price even higher.
We saw this happen two and a half years back with GameStop (NYSE:GME), the video game retailer that hedge funds like Melvin Capital heavily shorted. However, millions of retail investors on Reddit’s r/WallStreetBets forum decided to buy the stock driving up its price, resulting in Melvin Capital losing a staggering $7 billion.
Of course, not every short-squeeze stock will deliver such eye-watering gains, and there are some risks involved in going long on these stocks. These are stocks that are perpetually bleeding, and their businesses have poor fundamentals with high cash burn, which is the reason they are shorted in the first place. Thus, I would only suggest investing in them if you are prepared for some potential heavy losses.
With that in mind, here are three such short-squeeze stocks:
Carvana (NYSE:CVNA) is the most shorted stock on the market, with a short interest of 63.53%, ahead of even Silvergate (NYSE:SI). Indeed, it has been burning a lot of cash due to the used car business slowing down. The business being entirely online makes it difficult as customers are more likely to strike a better deal at their local car dealership. The cars sold by Carvana are slightly more expensive than ones sold by dealerships, and that matters in this environment.
But that’s not even the worst part. A lot of Carvana’s problems stem from its massive debt load of nearly $9 billion. Much of that debt is floating rate, meaning the business faces a lot of pressure in the current environment as interest rates peak. This also leads to share dilution since Carvana does not currently generate enough cash to cover its expenses and debt repayments.
Conversely, much of this is already priced in, with the stock down more than 97% from its peak. The company can also use its $3.9 billion of available liquidity to stay afloat for at least the entirety of 2023. I believe it can survive longer through debt restructuring and cooperation with other companies. Carvana will likely survive this cycle; it will continue to feel the pinch for years due to its high debt, but the short interest here seems a little too much.
Thus, betting against the bears is a good idea. But I would warn that good news is unlikely to come anytime soon.
Upstart (NASDAQ:UPST) is among the unlucky names, as the AI-based lending platform was among the fastest-growing stocks just a year ago. But as rising inflation and the Federal Reserve’s rate hikes created fear, Upstart’s momentum fell apart, and the stock has been languishing 96% below its peak. The short interest here is 36.8%, revealing the gloomy outlook for the business.
Nonetheless, I remain bullish on the company’s core concept. Upstart’s AI lending has outperformed FICO and is much safer compared to what is traditionally used by banks. Personally, the downfall of the company’s financials is not an Upstart problem but rather a banking sector problem since banks have substantially cut down on their lending.
In the long term, I expect a strong recovery once banks feel comfortable increasing their lending, which could lead to a short-squeeze.
Luminar Technologies (LAZR)
Luminar Technologies (NASDAQ:LAZR) is among the lower-risk bets among short-squeeze stocks. The company’s fundamentals are starting to turn a corner, and seems to be expanding pretty fast. LAZR stock also trades at a relatively discounted price due to earlier selloffs. Thus, the 26.87% short interest here seems overdone.
Furthermore, the most bullish argument for LAZR is its rapidly growing sales. The company’s revenue is expected to recover strongly, reaching $88 million this year and more than triple to $274 million next year. It has a backlog of $3.4 billion.
Bears argue that LAZR is unprofitable and will remain so for the foreseeable future. However, the accelerating growth in sales is worth the losses, as it has enough liquidity and room to take on more debt.
On the date of publication, Omor Ibne Ehsan did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.