3 Stocks with Fast Upside Potential Due to High Short Interest

Key Points

• Short interest has risen recently for these three stocks, giving them a high probability of breaking out to new highs.
• Backed by the fundamental thesis around their businesses, analysts have stepped up to back their potential rallies.
• Monitor what investors need for their portfolios in today's economy.

Whenever stocks reach a higher than usual short interest, investors could benefit from keeping a close eye on the future prospects for those stocks. Typically, there is a good reason for short sellers to take on a bearish view of businesses. However, like bullish sentiment, bearish sentiment can get out of hand.

A saga like GameStop Corp. NYSE: GME could happen if short interest becomes too high. GameStop’s short interest reached $7 billion in 2021, so a single tweet from “RoaringKitty” was enough to send the stock to its all-time high. While these stocks aren’t as heavily shorted as GameStop once was, short interest is still high enough to potentially send them higher soon.

Recently, the high short interest in SoFi Technologies Inc. NASDAQ: SOFI, Sprouts Farmers Market Inc. NASDAQ: SFM, and even Williams-Sonoma Inc. NYSE: WSM has seen its short interest rise to unusual levels. While there is always a reason to sell, these stocks outweigh it with more reasons to buy instead.

What High Short Interest Means

When someone sells a stock short, that investor must borrow a stock they don’t own and then sell it to the market. If the stock declines, that person can buy back the stock at a lower price than what it was borrowed for – that’s where the profit comes in -.

When short interest is high, most of the outstanding shares in the market are held in short positions, which means they need to be repurchased to be closed. So, if a stock rises relatively quickly, the high short seller population could hit max pain and look to close out their losers (buy the stock).

If this behavior is triggered on a large scale, massive buying activity could create a compound effect that causes the stock to rally to new highs, as happened to GameStop and AMC Entertainment Holdings Inc. NYSE: AMC in 2021.

With that understanding, investors can see why these three stocks could soon trigger mass buying due to their high short interest.

Mortgage Bounce Backs Could Send SoFi Higher

The real estate sector is currently in stalemate, as 7.3% mortgage rates and average home prices that are 32% higher than pre-pandemic levels keep would-be buyers from entering the market.

According to the Intercontinental Exchange, most outstanding mortgages in the U.S. carry an average interest rate of 3.25% today, so homeowners aren’t looking to sell their cheap mortgages.

Now that the Federal Reserve (the Fed) is proposing interest rate cuts as soon as September 2024, according to the CME’s FedWatch tool, lower mortgage rates could also spark new demand for those looking to finance a new home.

Carrying an 18.2% short interest today, bears stand against earnings per share (EPS) growth projections for 200% this year set by analysts. Because SoFi stock trades at only 59% of its 52-week high, chances are high that a positive quarter – or any easing housing news – could send the stock higher to catch up.

How high? Analysts at Jefferies Financial Group think SoFi stock could reach $12, daring it to rally 73.9% from its current price.

Price Initiatives Lined Up Sprouts Farmers Market For a Rally

Peers like Target Co. NYSE: TGT, Aldi (privately owned), and others have led the way in price cuts on thousands of items. This is a rare occurrence, as once prices are set on the rise, they do not often come back down to pre-inflation levels.

Sprouts have yet to announce its own round of price cuts. Recent quarterly earnings sent the stock rallying by nearly 30% since the announcement, a price action that could set up the company to price in better guidance for the rest of 2024 if these price cuts are announced.

While no analysts have felt the need to stick their necks out on this stock, current price targets could see an adjustment to the upside if and when these price announcements are set, which is where investors could see a path to higher stock prices.

While not as clear of a play as SoFi, Sprouts’ 11.9% short interest (as a percentage of total shares) could prove dangerous if these bearish traders step on the wrong end of price cuts.

As an inflation-choked consumer may look to ease their current financial burdens, price cuts (seemingly damaging in the short term) could prove bullish for market share and long-term demand.

After SoFi, It’ll be Williams-Sonoma Coming Next

Following this real estate comeback thesis, furnishing a home typically comes after securing a mortgage. This is where Williams-Sonoma could prove dangerous for its short sellers, who recently brought the stock’s short interest up to 10.7%.

Wedbush analysts think Williams-Sonoma could reach $350 a share. To prove these projections right, the stock would need to rally by 19.3% from its current level, making it the company's new all-time high price.

The company’s financials show a gross profit margin of up to 44.8% in the past twelve months. This allows management to keep more from each dollar sold, which feeds directly into the company’s leading profitability rates.

Following return on invested capital (ROIC) rates for Williams-Sonoma, investors can notice a 26% to 31% ROIC over the past five years. As annual stock price performance typically follows the long-run ROIC rate, this is one-way investors can compound their wealth in Williams-Sonoma once short sellers step out of the picture on the housing comeback.