This article examines some of the most shorted financial stocks on the market. More specifically, we’re looking at financial stocks short sellers are targeting that you may want to sell before it’s too late. The uncertain economic environment warrants analyzing financial stocks sold short by market participants, as a divergence is likely to occur.

Significant short selling of a stock generally means market participants believe it is overpriced. However, other rationales exist for short selling. For example, some market participants short-sell stocks to rebalance their exposure, while others short-sell stocks to borrow funds. Therefore, a holistic view of short selling is required before assuming a stock is overpriced.

Considering the aforementioned, I screened through the most shorted financial stocks and subsequently assessed their prospects. Three stood out to me; let’s discuss each in depth.

B. Riley Financial (RILY)

B. Riley Financial (NASDAQ:RILY) fills a critical void in the investment banking industry. In fact, I think its emphasis on liquidations and small-cap investment banking is highly lucrative in today’s economy. However, market participants clearly disagree with me, as about 76% of RILY stock’s float is shorted.

Okay, so RILY stock is heavily shorted. Now what?

Firstly, consider that RILY stock’s short interest is likely consequential to its near 30% month-over-month surge, which has driven its price-to-book ratio above 2.22x. In essence, this implies that investors are trimming their exposure instead of banking on fundamental weakness.

Regardless of the overarching rationale, I think investors are wrong to short RILY stock.

B. Riley is positioned to benefit from a recovery in the investment banking arena. Although a private market observation, EY expects distressed and restructuring private equity activity to top other categories in 2024. Such activity could relay into the liquidation space, handing B. Riley Financial lucrative opportunities. Furthermore, small-cap opportunities exist in digitalized finance, a rapidly growing industry with numerous corporate finance activities waiting in the wings.

In conclusion, I think things are looking up for RILY stock. Even though the company’s fourth-quarter revenue of $347 million dropped by 9.2% year over year (YOY), industry-based aspects suggest the firm will rebound this year. Moreover, the negative market consensus provides investors with an excellent contrarian investment opportunity.

Upstart Holdings (UPST)

It doesn’t get more cyclical than Upstart Holdings (NASDAQ:UPST). I mean, we are talking about a credit intermediary that relies on future credit scores instead of realized credit scores.

For those unaware, Upstart is an AI-driven credit intermediary that facilitates debt to consumers based on peripheral variables such as their education and career prospects. Although the firm’s business model is promising, the tight economic environment has suppressed speculative-grade credit offerings from banks while crunching the labor market.

A look at Upstart’s fourth-quarter earnings adds substance to the argument above. Despite beating its EPS target by 3 cents, Upstart’s loan originations settled at $1.3 billion, a 19% YOY decline. Additionally, Upstart forecast an $8 million net interest loss for its first quarter amid resilient funding costs.

Approximately 36% of UPST stock’s float is shorted, and its price-to-sales ratio of 4.02x doesn’t do it justice. On top of that, the shady economic environment will likely compress speculative loan volumes even further in the latter stages of 2024.

It’s not all sunshine and rainbows for UPST stock at the moment.

Lemonade (LMND)

Lemonade (NYSE:LMND) is another prominently shorted stock, with approximately 32% of its float shorted. Moreover, Lemonade’s days-to-cover ratio of above 10 suggests that short-seller liquidity can be an issue, adding additional turbulence to its stock price.

For those unaware, Lemonade is an insurance company, offering various short- and long-term solutions. The firm recently beat its fourth-quarter earnings estimates, surpassing its revenue target by $3.99 million and its EPS target by 19 cents. However, upon revealing its earnings, Lemonade stated that it doesn’t believe its first-quarter earnings will reach the average analyst’s estimate of $119.5 million. The market didn’t receive the news very well, as Lemonade’s stock slumped by more than 9% in after-hours trading on the day.

The question now becomes: Is Lemonade’s guidance the only reason for the short interest? No. Lemonade’s guidance plays into a bigger picture. You see, Lemonade has a quick ratio of merely 0.7x and a current ratio of only 1.16x, suggesting its balance sheet is thin. As such, underwhelming top-line figures could introduce additional liquidity concerns. On top of that, the company plans on doubling its growth budget in its next financial year, inviting additional solvency concerns as the economy is in an uncertain state.

Although the stock’s price-to-sales ratio of 2.6x isn’t bad, sustainability seems to be the main problem here.

I don’t think Lemonade will fail, but the market is certainly banking on severe headwinds!

On the date of publication, Steve Booyens did not hold (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.