Buffett's buy into Sirius XM's short interest, a new sudden rally

Key Points

• Sirius XM is Buffett's latest buy, not only because of its discount to the sector and the market but also because of the reasons the market is hiding from everyone else.
• One of the reasons for the favorable valuations given to the stock's multiples could be its high short interest.
• With recent rallies and Buffett's quality stamp, a massive run to cover short positions could fuel new highs in this name.

Only a handful of individuals in history can nod when others advertise them as having a sort of Midas touch, where everything they lay their eyes on seems to turn gold. Warren Buffett can be referred to as the Midas of the stock market, where every stock he picks is almost presupposed to be a sure winner.

And as he is a value investor, Buffett understands that going against the market's consensus is typically where the big payoffs are found. Notorious for avoiding technology stocks, since he doesn't invest in what he can't understand, he did find one worthy mention in the space for a value play in Sirius XM NASDAQ: SIRI.

The year 2023 has come to an end, and one sector clearly outperformed the broader S&P 500 index, the Communication Services Select Sector SPDR Fund NYSEARCA: XLC. Taking its price action against the S&P, you will notice a massive 24.7% outperformance during the year, and the reason why Buffett even started looking at Sirius XM.

Playing catch-up 

Sirius XM stock underperformed both the communications sector and the broader markets, creating the opening for Buffett to start developing a bargain purchase into it. Taken as an average, the broadcasting radio and TV industry trades at an average of 77.6% of its 52-week high prices, where Sirius XM falls behind once again.

Because it trades at 69.0% of its 52-week high today, Sirius XM stock is considered to be in a bear market, following Wall Street's definition, which is a 20.0% decline or more from high prices. If price action is market consensus, Buffett is indeed betting against it for a big swing in proving them wrong.

Now, there are other ways the market quietly agrees with Buffett here, especially when you break down the industry. This time, you will look at the forward price-to-earnings ratio, which is the market's way to slap a value on the future earnings potential of a stock.

Because Sirius XM trades at a 17.1x multiple, the markets willingly pay a premium of 168.0% over the industry's average 6.4x average forward P/E. As the saying goes, "It must be expensive for a reason." What reason this is? Well, that's a question for Buffett's crystal ball.

Analysts don't see it either, as earnings growth expectations are set at 3.2% for the next twelve months. With a price target set at $5.0 a share, there is an implied downside of 8.2% from today's prices. So, what is the reason the stock is rising so aggressively? 

A nearly 32.0% rally in the past month could be only the beginning of what's to come for this stock quickly.

Bears will run 

Do you remember all the fuzz around the GameStop NYSE: GME mania during 2021? Hedge fund giants got burned by a band of Reddit rebels pumping the stock and sending it to all-time highs in months; the reason wasn't because Wall Street had found the next unicorn company but because of its short interest.

So look, when stocks have high short interest as a percentage of their float... woah woah, okay, here's what all this means. Shorting a stock involves a complex process of borrowing shares, selling them, repurchasing them later, and giving them back. 

In plain English, you need to pay for something with money you don't have, so you ask your friend, "Hey bud, can I borrow your dollar? I'm short a couple of bucks and need to pay something; I'll cover you (payback) tomorrow".

You are now 'short' the dollar your friend gave you, and you gave that dollar away to pay, so now you need to pay your friend back. To pay back, you need to get a dollar from the market to give it back and close your loan right? 

What happens if thousands of people do this, and when it comes time to repay, thousands of dollars come in demand to be gotten in order to repay? This demand will drive the price of the dollar higher.

The same thing happens to stocks, and MarketBeat allows you to check the level of shorts any stock carries so you can spot opportunities where a lot of demand may come in for closing these short positions. With Sirius XM, today's 28.5% short interest as a percentage of all shares puts the stock at risk of a massive rally.

Now that Buffett has slapped his quality stamp on the stock, a continued rise in its price could trigger a wave of shorts to close their position, creating a massive demand for shares and fueling an even larger rally. Once again, Buffett is termed Midas, the stock picker.