The Shorts are out at Krispy Kreme
Looking for Opportunity and Danger in the markets? Read on and remember, my opinions are my own, and may cause you to lose your house …
The table to the left has been taken from the Yahoo Finance page on Krispy Kreme Donuts (KKD) – Notice the figure in the red circle I drew?
48%! There are short positions for 48% of the outstanding float – that is an impressive figure. If you’re not sure what a short position is, here is a quick description from about.com:
When someone shorts a stock [sometimes called "selling short"], they borrow shares of a company from an investor and sell those borrowed shares at the current market price. The hope is that the stock price will fall so the short seller can repurchase the stock at a lower price and pay back the person they borrowed from.
When investors take short positions they are anticipating the price of the stock to drop – which is something that has definitely been happening with Krispy Kreme (see the chart below). These shorts have made plenty of money over the past 8 months as KKD stock has fallen from about $35 in May of 2004 to about $10 today. If you were to have taken a short position in May, you would be looking at a profit of $25 per short position (35-10) – All you would have to do to realize your profit would be to buy the stock at the current market price, to return the shares that you had previously borrowed.
Currently, there is alot of negative sentiment about KKD’s future, and this is reflected in both the falling price, and the high Short Percentage of Float. As reference, shorts represent about 1.4% of oustanding Microsoft float, and about 1.6% for Southwest Airlines. When compared to these figures, you can see why 48% caught my attention.
The Short Bounce
When I look at KKD, I see both opportunity and danger.
- Opportunity - Play the Short Squeeze. Eventually, all the shorts will need to purchase shares to replace what they have borrowed – With companies like Microsoft and Southwest Airlines, the proportion of shorts are not large enough to cause a significant change in the price, but with nearly half of the outstanding stock currently borrowed, the affects of shorts could be great for KKD. If the price starts to move up, Shorts will rush to secure their profit, and the stock will quickly appreciate – resulting in the “Short Bounce”.
Following from this view, there are two scenarios that would make then buying the stock for the short term a rational strategy:
- You think the stock has bottomed out and the company will survive (more of a longterm approach)
- You come to believe that the shorts, at a certain point, become scared of stock price appreciation (obviously more short-term)
- Danger – Hopefully, you realize this is a risky strategy. These shorts are shorting for a reason. Along with KKD, PWC is caught in a mess of accounting errors, the management team is under investigation for some dubious franchise repurchase agreements (involving ex-wives), and the Atkins diet is telling people to stay away (is Atkins still king, or has south beach taken over the throne?). If you buy the stock, there is a chance you will lose ALL your “investment”. If you were to buy the stock you would clearly be purchasing a crappy company, but it might just be a crappy company with an upside.
The big question about KKD isn’t whether they will survive, but rather what they will do with all the “liquid Doughnut” mix they made and nobody bought.
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