Shares of Dillard’s (DDS - Free Report) soared more than 8% in morning trading Tuesday after a new report suggested that the stock appears to be heading for an “infinity squeeze” akin to Volkswagen’s (VLKAY - Free Report) legendary short squeeze in 2008.
According to Richard Pearson of MOXReports, a combination of alarmingly high short interest and a lack of shares available for purchase could lead to a short squeeze of epic proportions on DDS.
“It seems that this ‘double whammy’ of rising short against falling float had escaped the attention of short sellers who should have been paying attention,” Pearson wrote.
“The third leg of this ‘triple whammy’ is this: Of the 12.88 million share float, as much as 6 million shares are in the hands of index funds (including Blackrock, Vanguard and others) who are typically unable to sell in meaningful size, even when the share price rises sharply.”
Pearson points to a series of relatively unnoticed share buybacks by Dillard’s as the cause for the reduced float. Citing Bloomberg figures, he notes that this has caused short interest to rise to 69.9% of float, and his thesis suggests that short sellers will be hard-pressed to cover given the limited supply of available shares.
Hypothetically, this would mean that existing holders could hold out for significantly higher prices as shorts look to close their positions.
It is also worth noting that Dillard's short interest ratio—also known as days to cover—is above eight days right now. In other words, it would take short sellers roughly eight days to close out of all of their positions assuming normal volume levels. Not exactly an enviable position, and something that could create a dreaded “short squeeze” in the process.
A typical short squeeze happens when a positive development suggests that a turnaround is on the horizon for a heavily-shorted stock. If a stock starts to rise rapidly, shorts will want out of their positions, and if enough shorts buy back the stock, its price moves even higher.
For more information on how short squeezes work, check out this recent episode of the Dutram Report podcast, hosted by Zacks ETF Strategist Eric Dutram:
In his report, Pearson compares the current situation with Dillard’s to that of Volkswagen in October 2008. In what would become one of the most incredible short squeezes of all time, Volkswagen’s stock skyrocketed nearly 400% in a matter of days, briefly making the German automaker the most valuable company in the world.
How did this happen? Well, earlier that year, Porsche—which owned about 31% of VW—publicly stated that it did not intend to increase its stake. The German state of Lower Saxony owned about 20% of VW at the time, and Porsche presumably thought it would be too costly or difficult to acquire the other shares on the market.
However, in late October, Porsche revealed that it actually did up its stake to about 74% of shares outstanding. With about 13% of the company on loan to short sellers, the market had a big math problem, and shorts incurred billions of dollars in losses.
In the case of Dillard’s, Pearson is arguing that the company’s own share buybacks have created a situation that is akin to Porsche’s surprising decision to buy up all of Volkswagen’s available shares.
Pearson’s full report is interesting, and I would encourage readers to check it out if they are interested in hearing more about his theory. There are several elements of the Dillard’s situation that are characteristically different than the Volkswagen situation, but if Pearson’s math is correct, he could be on to something.
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