This morning The Wall Street Journal wrote an article “Netflix’s Massive Rally Draws Attention of Skeptics.” The title of the article should have been “Netflix’s Critics Fail To Put Their Money Where Their Mouth Is!”
The noted skeptic in the article was short seller, Andrew Left of Citron Research, who has a business model that should be made illegal by the S.E.C.
Short a stock and then write a research note on it, publish the report and go on CNBC to hit on the basics of the report. Cover after your appearance drives it lower. Seems rather illegal to me and it is surprising that such a tactic is legal, but apparently it is.
The Wall Street Journal article also highlighted a sell side analyst, Scott Devitt of Stifel, who took his rating to a hold on March 7. However, the price target went from $285 to $325. That is quite a downgrade, not. Every time I see such a move, it makes me laugh.
Take from buy to hold but increase the price target by $40. The current price is $323.74. Devitt wrote that “share price may have sprinted ahead of fundamentals in the short term.” Really?
Devitt’s target is now $325 so how is it ahead of its target? It was ahead of the target when the target was $285 but it is not now with a target of $325. Oh by the way, Devitt missed the $40 rise to $325. We put a call into Devitt but he did not respond.
The third skeptic was not really a skeptic. Rather it was Netflix CEO Reed Hastings who noted in 2015 that the stock was extended and he did not know why. There was nothing from Hastings on the company in the article besides the 2015 comment. It makes you think Hastings is okay with the current valuation.
What should have been highlighted in the article is that the shorts began to increase their absolute short selling in the second half of March 2017. The price then was $142.92 when March 31 short interest collection was released on April 11.
Shorts pressed until a peak on September 26 when the September 15 collection was released. The price on September 26 was $179.38. So the price of Netflix rose by $36.46 or 25.51% as absolute shorting increased.
A review of absolute short interest is one way to track how the short sellers are fairing. Another way to review short interest is to look at the shares short as a percentage of float. We prefer to track the range of the short ratio over time and then assign it a short intensity rank.
The short ratio is the only variable that tells you exactly how many days it will take the shorts to cover their position. The short ratio is also known as the “days to cover” ratio.
We begin to track heavy short selling when what we call the “short intensity” rises above 80%. We track it until it drops below 50%. For Netflix, the last time it moved above 80% was on March 24, 2017, and the price was $144.06. The short intensity finally dropped below 50% on February 27 at a price of $291.38. The move was 102.26%. However, the best short squeeze in Netflix came in March of 2005 to May of 2006 when it rose 193.97%.
Short sellers could have avoided this pain if they did not short into a crowd or they looked at their batting average in shorting a stock. This type of short selling can either cause extreme pain or be extremely rewarding. In the case of Netflix, it causes extreme pain.
Since Netflix has been public, there has been heavy short selling eight times. 62.5% of the time, the short are squeezed. The average squeeze is 66.4%. When the short do make money they make a paltry 4.6%. With such odds, it does not make sense to short into a crowd on Netflix.
It is also notable that the shorts in Netflix will stay with their position for an average of 150 trading days. In the latest bout of short selling, the shorts did not capitulate for 231 trading days. So the takeaway is that one can surmise the short sellers in Netflix are “really” stubborn and must like to lose money.
The time to short Netflix will be when all the shorts are gone and the technicals begin to lag. Then the opposite of a short squeeze will begin, the dreaded long squeeze unfolds.
In a long squeeze, there are no shorts to cover and longs sell without shorts helping to balance out the demand for shares. The stock drops day after day. Equinix (EQIX) just completed the dreaded long squeeze with a drop from $495.35 to $370.79.
At some point, Netflix will become a long squeeze like Equinix and we do expect to write about this at some point in the future. Now, that will be a much better story than “Netflix’s Massive Rally Draws Attention of Skeptics.”
Geoff Garbacz is the co-founder and one of two principals in Quantitative Partners, Inc. (QPI). Geoff and his team at Quantitative Partners have over 36 years of experience on Wall Street. Prior to the formation of QPI in 1995, Geoff worked for The Robinson Humphrey Company from 1990 to 1995.
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