Is lemonade the short-lived action of 2022?
Explosive price action on stocks even as AMC (NYSE: AMC) and Gamestop (NYSE: GME) in 2021, put the idea of a “short squeeze” in the minds of retail investors, who are now looking for the next potential stock that could climb higher.
While those memes stocks ended up being extreme cutbacks, to a lesser extent, short sellers beat an insurance tech company Lemonade (NYSE: LMND) also. Here’s why he might be a short-term candidate in 2022.
What is a short press?
Before explaining a squeeze shorts, let’s start by explaining the short itself. When a stock is sold short, investors borrow stocks and sell them in the hopes of buying back the stock later at a lower price. For example, if I sell 10 XYZ shares at $ 100, I receive $ 1,000 from the sale and owe the broker 10 XYZ shares. Let’s say three months later, XYZ is trading at $ 80 per share, and I redeem those 10 shares to “cover” my short position. I spend $ 800 to buy these 10 shares and return them to the broker; the difference of $ 200 between what I received from the initial sale and what I spent to buy back the shares is my profit (less potential fees and commissions from the transactions).
A short squeeze occurs when many short sellers attempt to buy back stocks to cover their short position all at once. This action creates a buying frenzy from too many buyers looking for too few available stocks and can push the stock price much higher in a short period of time. When this happens, shorts try more to buy stocks because they lose money as the stock price rises, which only fuels the buying frenzy.
This graph shows the percentage of Gamestop’s publicly traded shares that were sold short at the time of its short sale. Gamestop’s shares were sold so heavily short that short sellers would re-borrow shares that had previously been loaned to other short sellers. This is how the percentage can exceed 100%, and this extreme level of short selling has caused the Gamestop share price to rise significantly.
Why is Lemonade so heavily shorted?
This chart shows how shorts have exerted increasing pressure on Lemonade stocks over time. About 35% of Lemonade’s shares are short; not as much as Gamestop, but it’s still a high number that makes Lemonade one of the shortest stocks on Wall Street.
So why is lemonade such a popular stock with short sellers? Lemonade enters the insurance industry as a disruptor, using artificial intelligence-based robots and a mobile app to speak directly to customers and deliver an engaging digital experience for young users.
Insurance is a highly competitive multi-trillion dollar industry globally, and large existing players like Geico dominate it. Lemonade spends heavily on marketing to penetrate this massive competitive space while simultaneously creating new product offerings.
In Lemonade’s nine months of fiscal 2021, the company generated $ 87.4 million in total revenue, but recorded a net loss of $ 171 million. The company spends more on sales and marketing than its total revenue this year.
The prospect of rising interest rates has become increasingly prominent throughout 2021, with investors selling shares of unprofitable or speculative companies. Lemonade is in that group, down almost 80% from its earlier this year highs.
What could make Lemonade soar in 2022?
Often it takes an event or a catalyst that sets in motion a short press. In the case of Lemonade, this catalyst could be an advancement in the development of its auto insurance product that shows the market that Lemonade could become a serious competitor in insurance.
Its auto insurance product, Lemonade Car, was launched a week before the company released its third quarter results. At the same time, it announced the acquisition of Metromile, an existing insurance technology company involved in auto insurance. Lemonade acquires Metromile in an approximately $ 200 million stock transaction, subtracting the $ 300 million in cash from Metromile’s balance sheet.
The acquisition gives Lemonade billions of miles of driving and claims data to help it refine its algorithms faster, as well as an existing auto insurance presence across the country that is expected to accelerate the rate at which Lemonade can develop Lemonade Car. The auto insurance industry is worth over $ 300 billion in the United States alone, so this is a great growth opportunity for Lemonade.
If investors become more convinced of Lemonade’s ability to disrupt insurance over the next few quarters, the shift in sentiment could be what the stock needs to send short sellers scrambling to hedge their positions.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.