Short Interest Matters

Mary MacNamara from Interactive Brokers speaks with Russell Burns of Finimize about what it means to go long or short in investing, and why short interest matters.

Summary – Cents of Security Podcasts Ep. 112

Mary MacNamara

Hello everybody. Welcome to Cents of Security Podcast. I’m Mary MacNamara at Interactive Brokers, and today we’re going to talk long versus short and short interest. I welcome Russell Burns with Finimize. He’s going to be our guest today and answer these questions for us. So good to see you, Russell. How are you?

Russell Burns

I’m very well, thanks for having me on.

Mary MacNamara

Oh good. Okay, so first question right off the bat, let’s remind everybody what going long or short means in investing.

Russell Burns

Yeah, sure. So going long means buying a stock, expecting its price to go up so you can ideally sell it later for a profit. Going short means selling a stock that you actually don’t own by borrowing it, expecting the price to drop so you can buy it back later at a lower price.

Also, making a profit.

Mary MacNamara

Great. So, it’s win-win. It just depends on what side you’re playing, right? A little bit.

Russell Burns

Exactly. If you get it right, both sides, you’re a genius. It’s not easy to do always, but that’s the idea.

Mary MacNamara

So, for someone new to the markets, how would you explain short interest?

Russell Burns

Yeah, short interest is the number or the percentage of outstanding shares of a stock that have been sold short at a particular point in time. So, if there’s a million shares outstanding of a company and a hundred thousand shares are shorted, that would be a short interest of 10%. So, you can normally think about it as the higher, the short interest percent, the more negative investors are on the share price outlook.

Mary MacNamara

Is there a normal level of short interest for a stock, generally, or does it, is, does it depend on the company itself?

Russell Burns

Yeah, there’s no normal number that fits all stocks all the time, and the answer will typically depend on the company. Its sector balance, sheet strength, current news, and the state of the overall market for the biggest companies in the US right now, like Nvidia, Microsoft, short interest percent, currently under 1%, Tesla’s at two, and Intel’s a bit higher at three. And the short interest percent may be higher for smaller companies for a couple of reasons. One, it takes a smaller dollar amount to impact the overall number. And two, and probably more importantly, smaller companies have generally been less popular for a few years now. So, examples of high short interest names are like Carvana and Rivian, which have 9% and 12% short interest percent.

And if a company’s got a double-digit percent short interest, that means there’s quite a lot of investors are bearish on its outlook.

Mary MacNamara

So why would a stock have a high short interest, even if the company’s not really doing terribly or badly?

Russell Burns

Yeah, there could be a few reasons for that. The company could be doing really well, but the stock price may have run up too far too quickly and valuations look really expensive. Or two, it could be because traders expect future problems for the company or the sector, which could be caused by macro factors, geopolitical changes, or new competition coming in. Perhaps the speculation that the company may be about to issue new equity to finance further investment or expansion, and investors would want to be short ahead of that announcement to take advantage of the likely drop in the share price. But it’s also worth being aware that just because a company’s got a high short interest is not always negative.

Because let’s say if a company’s issued a convertible bond, some of that short interest would probably relate to hedging out the long exposure from the convertible bond. So, the short interest could be high, but it’s more technical in nature, not just because traders or portfolio managers are overly bearish on the company’s outlook.

Mary MacNamara

Oh, that’s so interesting. What are some red flags here in the financials that might justify a high short interest like debt levels, declining revenue, or shrinking margins? You may have just covered this a little bit, but can you add to that?

Russell Burns

Sure. Yeah. All of those above can be red flags. If company’s got high debt levels, you need to look a bit closer to see when the loans have to be paid back, what, whether the debt’s at a fixed or a floating rate, can the company cover the debt payments from cashflow and for how long? If revenues or profit margins have gone down or expected to fall in the future, that may also justify a low valuation and a higher short interest, especially if it’s caused by something structural rather than just a short-term event. Another important red flag to look out for is if there’s signs of aggressive accounting methods that may make cashflow or profits look artificially higher. That can come from actions like channel stuffing, where companies ship excessive inventory to distributors, but the actual products aren’t selling. Or it could be where profits are growing, but companies have weak or deteriorating cash flow. And that could come from companies trying to spread expenses over a number of years, temporarily boosting profits, making performance look stronger than it actually is.

Mary MacNamara

Do short sellers tend to focus on specific areas or ratios like cash flow, earnings quality, or inventory buildup.

They’d look at ratios for sure. Using financial ratios will be a great way to screen for ideas. It could be like high valuations on, basic metrics like price to earnings ratios, and they’d look at those on, it could be on an absolute basis or relative to a company’s history or the sector.

See, some short sellers would look to invest using a sector neutral approach, like trying to go short an expensive company in the sector along a cheaper one. That’s where you’d try and find real alpha. And for sure deteriorating earnings could be a red flag. Missing profit forecast for a couple of quarters will get alarm bells ringing that maybe there’s problems under the surface that are worth looking closer at. So, there’s a variety of potential fundamental indicators that can be used, but often financials and fundamental valuations are not enough on their own. So, traders and portfolio managers may wait and look for technical indicators to be more favorable before going short. For example, price momentum turning down the stocks can continue to trade their expensive valuations for much longer than expected.

Mary MacNamara

I bet it’s very popular during earning season, right? This is where you see traders looking at this at short interest or in the sense of what’s going on in the world right now globally with tariffs, right?

Russell Burns

For sure. Around earning season, there’s always a lot of expectation. People would look at the options market to see what price moves are expected. Five, 10% one way or another for the higher volatility names. And then obviously, if a company’s got a very high short interest and too many traders are expecting the earnings to be weak and miss just because the earnings are weak.

It doesn’t mean the share price will necessarily fall if traders that are short want to cover, so the stock can squeeze higher on the back of it. So, it’s not always just what the earnings are, it’s like the outlook as well. And positioning ahead of the event is always important as well. So, for tariffs. Been a lot of short activity, at least in the near term, with companies that are expected to be impacted by, negatively by tariffs. A lot of shorts went out there, but it’s gets very noisy because headlines can change the outlook.

So, for copper mining related stocks, Trump announced copper tariffs and then reversed them, and these stocks were all moving up and down 20%. As people or traders try to anticipate the move position ahead of it, and everything else. So, headlines, especially macro and geopolitical ones, can make shorting much more challenging.

Mary MacNamara

So today, or I think it’s today, right? The FOMC is meeting, right? To discuss rates. Is there going to be a rate cut does that play into it too? It sounds like all these things could play into it.

Russell Burns

Earnings are obviously a big one because it’s stock specific. So, what we’re talking here is short interest on specific companies rather than the overall market. So yes, for sure if the S&P 500 falls, 3% or the constituents are probably going to go down to, so yes, for sure. But the FOMC would be more macro related.

People may not want to be short housing names because lower interest rates of the FOC cuts or the Jackson hole. It is this week it’s announced that, you know the outlook for rates is lower than expected. That’s expected to help sensitive sectors, people may not, or investors may not want to be short the housing sector, but if they think that Powell’s not going to agree, and he’s going to say there’s going to be no rate cuts for the next couple of months, it’s not what markets expecting.

But if they’re going against that, they may want to be short, interest rate sectors or stocks, because we’re not going to get interest rate cuts. So those macro factors can be as big as. Tariffs or it could be, it can literally be anything and everything, as you said. Yeah, there’s a variety of factors that impact the market sectors and single companies.

Mary MacNamara

Okay. What about we have this whole meme craze, right? Are they getting squeezed right now? The short sellers who are in that type of scenario.

Russell Burns

So short interest levels are released twice, a twice a month by the New York Stock Exchange, Nasdaq. So, it’s quite easy to monitor what the short interest percent is for companies, and that makes. High short interest names vulnerable to being squeezed out by investors if they choose to do it’s not easy to squeeze shorts in Microsoft or Nvidia because they’re much, much too big, but in small and mid-size names, high short interest names are vulnerable to getting squeezed as Reddit forums and retail investors have a lot of power now in the markets. So that happened a few weeks ago, and in COVID retail investors really took over the market and squeezed out some high short interest names and actually managed to put a couple of hedge funds out of business.

Mary MacNamara

Thank you for joining us, Russell. As always, listeners, you can learn more about an array of financial topics for free at interactivebrokers.com slash campus, and please follow us on your favorite podcast network and feel free to leave us a rating or review.

Thank you so much, and once again, thank you Russell.

Russell Burns

Thanks for having me.