Get Ready for a Short Squeeze

93 million.

That’s how many shares are short on one of my favorite investments right now.

With a total of 304 million shares outstanding, we’re talking about 32% of this company’s stock that has been sold short by traders who think the share price is going lower.

The thing is, over the last couple of years, these bearish bets have been absolutely correct, and they’ve generated some outstanding profits as the stock price has dropped. 

I know old habits die hard, but the time for this particular short play is over. The stock has fallen from $40 a share in January 2012 to around $9 today (the 52-week low is around $5). The downside profits have been made. The odds of another sharp move lower have declined dramatically.

And yet 93 million shares are sold short as of the last reporting period.

Now, if you don’t know, a short sale, or shorting a stock, is the opposite of buying a company’s stock in anticipation of a move higher for the price. When you sell a stock short, or just “short” it, you sell the stock first, with the expectation that you can buy it back later (“cover” your short) at a lower price. The price difference between where you sold it and where you bought it back is your profit. 

So if you short a stock at $40 and it falls to $9, you’ve done pretty darn well. But if you short a stock at $9 that’s already fallen from $40 and you think it’s going to fall more, well, that might not be the best decision you could make…

The Upside Story for J.C. Penney

The company I’m talking about is J.C. Penney (NYSE: JCP). It’s had a rough go of it, for sure. But things are looking much better for the company, and I think it will be a pretty good stock to own for the rest of this year.

I’ll explain in a minute, but first, let’s take a look at why the share price is where it is…

In 2011, J.C. Penney made a disastrous decision. Or I should say, one of the board members — a hedge fund guy named Bill Ackman — forced a terrible decision on the company.

Hedge fund guys like big, flashy moves, and Ackman’s plan to revitalize JCP centered on hiring a new CEO — Ron Johnson.

Ron Johnson helped make Target what it is. Then he left Target and went to Apple to launch the Apple stores. Those stores were (and still are) a phenomenal success.  

So Ackman thought Ron Johnson could do for J.C. Penney what he did for Apple and send Ackman’s investment in JCP soaring…

Wrong. 

The details of why Johnson’s transformation of JCP failed aren’t important. All you need to know is that in his mere 17 months at the helm, total revenue fell an incredible 27%, and the company lost $3 billion. You couldn’t do much worse than that if you tried.

No doubt about it: Ron Johnson very nearly drove JCP into bankruptcy. 

Fortunately, JCP knew a disaster when it saw one, and it pulled the plug on Johnson pretty quickly and brought back the old CEO, Mike Ullman. 

Ullman has been working to undo the damage over the last 18 months. And slowly but surely, the plan is working. Revenue has stopped falling, same-store sales have been showing ~4% gains, and gross margins have improved. It’s not recovered to what it was, but it’s on the right track.

Perhaps most importantly, Ullman was able to go to the bond market last year to raise cash. Yeah, he had to offer up 8% yields, but it’s a huge show of confidence by bond investors that the offering was over-subscribed.

Apparently the JCP shorts don’t see this as significant, but it is. Because it buys JCP time. 

JCP is closing stores, and it’s doing well with online sales. And JCP had about the best same-store sales growth of any retailer during the Christmas season.

It’s going to be a grind, that’s for sure. But bankruptcy is off the table. There’s no good reason to be short the stock anymore…

What’s Ahead

J.C. Penney just got an upgrade from Piper Jaffray last week. The firm believes same-store sales growth is running at 3%, much better than the previous estimate of 1%.

Throw in online orders, and sales are expected to be up 3.9%. That’s really good, and the Piper Jaffray analyst raised her price target from $13 to $14. That’s nearly 50% higher than current prices…

I can’t help but wonder what those shorts and their 93 million shares are thinking. The odds are rising that they are wrong. And at some point, they have to buy stock to get out of their short positions. 

If J.C. Penney keeps rallying, we’re going to see a short squeeze. That happens when shorts buy stock to cover their positions while the stock is rising. In fact, their buying helps push the stock higher, forcing more shorts to buy at ever-higher prices. 

I’m not recommending J.C. Penney because I think a short squeeze is a guarantee — I like the stock because it’s cheap, and the turnaround is working.

While I’m taking the long view and putting an 18-month price target of $20 on the stock, I also think a good short squeeze could get the shares to $20 a lot sooner. 

Until next time,

Until next time,

Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.