2 Stocks That Crushed Short Sellers With Impressive Gains

Key Points

• Short sellers who release bearish research reports intend to profit by causing investors to sell their stock, driving down prices to cover.
• While some bearish reports can sink stocks, they can also slingshot back, triggering a short squeeze that can be very painful for short sellers who take short positions after the reports are released.
• LRN stock rallied 45.4% higher, and AX stock rallied 79.5% higher on a short squeeze after bottoming out on short seller reports.

Short sellers are market bears that seek to profit from falling stock prices. Some of the more popular short sellers will put out their research reports attempting to expose a target company by implying misconduct or fraud in order to trigger investors to sell their positions. The selling action is supposed to beget more selling as the price falls, enabling the short seller to cover their short position for a profit.

However, things don’t always go as planned. The short seller can also encourage more short sellers to take short positions in the underlying stock, making the stock susceptible to a short squeeze. This can occur dramatically when the company disputes claims or releases materially bullish information. Here are two stocks that painfully backfired on short sellers.

Stride: Allegations of Inflated Earnings From ESSER COVID Funding

On Oct. 16, 2024, short seller Fuzzy Panda Research disclosed their short position in third-party education curriculum and platform provider Stride Inc. NYSE: LRN. They claimed that an “EBITDA cliff” was eminent for the consumer discretionary sector company as the last of the COVID fund subsidies were drying up. They purport that Stride's margin expansion was driven by government-funded elementary and secondary school emergency relief (ESSER) COVID funds, which is a federal program established under the Coronavirus Aid, Relief and Economic Security (CARES) Act in March 2020. The funds were intended to help schools reopen safely, maintain operations, and address the impact of the pandemic.

ESSER funds were distributed in three rounds labeled ESSER I through ESSER III. The final round of funding is required to be used by September 2024. Fuzzy Panda claims these “no strings attached” funds flowed straight to Stride’s bottom line at 50% to 75% margins, enabling the margin expansion. Moving forward, the lack of ESSER funds will result in a collapse in EBITDA. Fuzzy Panda goes on to include allegations and confirmations from unnamed sources along with the innuendos of implied fraud.

Bearish Report Triggers a 9% Stock Drop

As with most short sellers, they don't reveal their cost basis on the short position. One can assume their short position was taken way before the release of the short seller report, and the subsequent sell-off is when they cover their positions. In other words, they front-run their report release. The report from Fuzzy Panda was released on Oct. 16, 2024. LRN stock fell to a low of $63.37, down over 9% on the day from the previous day's close of $70.66.

Fuzzy Panda Gets Fried on Blowout Results as LRN Surges 45.4% Higher

Four days later, Stride reported a blowout earnings report. The company reported fiscal Q1 2025 EPS of 94 cents, crushing consensus estimates by 72 cents. Revenues rose 14.8% YoY to $551.08 million, crushing consensus estimates for $504.29 million. Additionally, Stride raised their Q2 revenue guidance to $560 million to $580 million versus $535.34 million consensus estimates. Fiscal 2025 revenues are expected to be between $2.225 billion and $2.3 billion versus $2.17 billion consensus estimates. Stride did acknowledge that the ending of ESSER funding would be a headwind to revenue and enrollment, resulting in revenue per enrollment ending the year flat or slightly down.

In reaction, the LRN stock gapped 39% the following day on a monster short squeeze that lasted two days. On day 2, the upside rally from the pre-earnings release closing price of $64.49 to $92.75 was 45.4%. While Fuzzy Panda didn't disclose where it entered the short or how much they profited, anyone who ventured to sell LRN stock short after the research report was released was unquestionably short-squeezed for losses if they held the position through the earnings release.

Axos Financial:  Hindenburg Attempts to Sink a Regional Bank on Its Loan Portfolio

Well-known short-seller Hindenburg Research released a report claiming regional bank Axos Financial Inc. NYSE: AX was a ticking time bomb due to its exposure to the riskiest asset classes and lax underwriting of commercial real estate loans. Hindenburg makes many comparisons and uses 21 unnamed former employees to imply potential accounting and valuation improprieties. It asserts the company made loans to known criminal borrowers and was overvalued compared to peers. The research was flimsy at best.

Hindenburg Goes Down in Flames as Stock Squeezes

Axos stock gapped down nearly 16% from its prior day's $52.46 closing price to $44.10 on the morning of the report release on June 4, 2024. However, the stock continued to rally back up to $50.35 highs into the close and gap fill back to $52.46 two days later, putting anyone who shorted the stock after the report firmly in the red.  However, the stock managed to climb 79.57% from the $44.10 low in the following weeks, reaching a high of $79.16 on July 30, 2024. Whether Hindenburg made a profit on its short position is anyone's guess, but anyone who shorted AX after the Hindenburg report clearly lost money.