I have written several articles about the FANG stocks with the most recent one being one month ago. In that article I compared the earnings disappointments of Facebook and Netflix with the earnings disappointment from Microsoft back in April ’00.
A recent Bloomberg article about the FANG stocks caught my eye because it talked about how short interest was increasing on tech stocks. Personally I use short interest and the short interest ratio on stocks as a means to gauge the sentiment toward a stock I may be considering a trade on.
The short interest ratio simply measures the number of shares sold short divided by the average daily trading volume. For instance, if there are 10 million shares of a stock sold short and the average daily trading volume is 2.5 million, the short interest ratio would be 4.0.
You should also know that this indicator is used from a contrarian viewpoint. If a stock has a high short interest ratio and is rallying, as the short sellers have to buy shares to cover their position, they are adding buying pressure to the stock. If the stock has a low short interest ratio, it doesn’t cause the stock to move down, but it is an indication of optimism toward the stock. I consider a short interest ratio over 5.0 to be high and below 2.0 as low.
When I first saw the article from Bloomberg, I got excited. I thought, “Wow, this is a good sign for the bull market.” But once I started looking at the article and then doing my own research, I was disappointed.
The article was measuring the amount of short interest in terms of dollars and not in the number of shares sold short or in higher short interest ratios.
Bearish investors have shorted about $37 billion worth of stocks in the group, which comprises Facebook Inc., Apple Inc., Amazon.com Inc., Netflix Inc. and Google parent Alphabet Inc., up 42 percent from a year ago. Amazon leads the way with almost $10 billion in short interest, according to data compiled by Bloomberg as of Aug. 28 from financial analytics firm S3 Partners LLC.
The problem with measuring short interest in monetary terms is that a rising stock price will offset a decline in the number of shares sold short. The passage above points out Amazon and how there is $10 billion in short interest. If you look at the number of shares sold short and the short interest ratio, both are down from one year ago. In August ’17 there were 5.1 million shares sold short and the short interest ratio was at 1.45. Now there are 4.8 million shares sold short and the ratio is at 1.09.
The reason the monetary amount is higher is because the stock is up 100% in the past year. If you do the math, there were 5.1 million shares sold short at $946. That is $4.8 billion and change. The stock closed at $1932.82 on Tuesday and if we multiply that by 4.8 million, we get $9.3 billion. Based on the monetary amounts, it looks like the short interest has nearly doubled. But that isn’t the case at all.
I did the same thing with the other four stocks. I put together a table of the number of shares sold short one year ago versus now and where the short ratio was then versus now.
As you can see, the only stock with a significant bump in the number of shares sold short is Facebook, but even then the short ratio dropped because the average daily trading volume is higher. Netflix saw a sharp drop in the number of shares sold short. But just like Amazon, if you measure it by the dollar amount sold short it would look like an increase of 33%. And that is because the stock is up 120% over the last year.
While I was disappointed in the findings compared to what I expected from the article, I thought it was a useful lesson I could share. The other thing the process did was let me know that the sentiment toward the FANG stocks is a little more optimistic than it was a year ago, but it isn’t at an extreme level that makes me think a bear market is on the immediate horizon.