February 1, 2021
By Andrew Boord, Portfolio Manager – Fenimore Small Cap Strategy
There is much discussion lately about highly shorted stocks getting squeezed higher, like GME (GameStop Corp.) — not a Fenimore holding.
- Short-Selling Basics: A short seller expects a stock price to decline. First, they borrow someone else’s shares and sell them at the market price. Later, they must return those shares to the rightful owner by going into the market to buy the same number of shares back (known as “covering”). If the stock price falls between the sale and the cover, then they earn a profit.
- Short Squeeze: A short squeeze can occur when a security has a relatively high, short interest. If other market participants buy shares pushing the price higher, the losses for short sellers can become extremely painful and cause the shorts in turn to buy more shares to cover their short positions. A squeeze is wave after wave of short sellers forced to buy shares to cover their shorts at higher and higher prices.
- Short Interest & GME: Short interest is usually measured by “days to cover,” which can be defined as the number of shares shorted divided by the average volume. GME was particularly vulnerable because the short interest was massive versus average volume. As a result, once the squeeze begins, the short interest struggles to buy enough shares to cover.
- Recurring Trend: While GME is an amazing episode that the marketplace is watching carefully, short squeezes are a recurring trend in market history.
- Key Reasons Why Fenimore Avoids Short Squeezes:
– Short squeezes almost always end with the stocks returning to their approximate starting levels.
– Even as investment professionals with decades of experience, we never know exactly what catalyst drives a stock price over the short term. That is why we believe that investing with extensive research and knowledge, and a long-term perspective, is mission critical to managing risk and growing capital.
– Fenimore does not speculate with our investors’ hard-earned assets. We are dedicated to protecting our investors’ capital and see these market anomalies as interesting to watch, but critical to avoid.
