If a stock has a high level of short interest, it’s often a red flag. Short sellers tend to do their research and if they’re targeting a stock, there’s usually a very good reason they are doing so.
In this report, we are going to look at the short interest data on DigitalOcean Holdings Inc (DOCN:US). DigitalOcean is an American cloud infrastructure business. The company, which aims to help customers spend less time managing their cloud infrastructure, is focused on serving developers, start-ups, and SMBs. It’s listed on the New York Stock Exchange and currently has a market cap of $3.99 billion.
DigitalOcean Holdings: Short Interest Data
Looking at the data on DigitalOcean, there are two things that stand out.
The first is that there is a large number of shares on loan. Our data shows that at present, 11.6 million DOCN shares are on loan, which represents 68.37% of the free float. This is concerning as it indicates that a lot of hedge funds and other institutional investors are bearish on the stock.
The second thing that stands out here is that the number of shares on loan has risen dramatically in recent months. At the start of May, there were just 4.9 million shares on loan here. However, since then, the figure has ballooned to 11.5 million – an increase of 135%. Meanwhile, utilization – a measure of demand from short sellers – has risen from 14.3% to 38.6% over that period. These figures indicate that the short sellers have been ramping up their bets here.
Why Are Short Sellers Targeting DigitalOcean?
So, what is it that the short sellers see here?
Well, it could be the company’s valuation. At present, analysts expect the group to generate earnings per share of $0.66 this year. That puts the stock on a forward-looking P/E ratio of about 65. Meanwhile, the price-to-sales ratio is about eight. These valuations are quite high, especially in the current environment.
Short sellers could also be focused on a potential slowdown in business spending. It’s worth noting that Morgan Stanley analyst Josh Baer recently downgraded DigitalOcean to underweight (sell) from equal weight (hold), citing the growing risk of a slowdown in software spending. Baer believes a slowdown could be more pronounced for DigitalOcean due to the company's exposure to small businesses, start-ups, and individual developers.
Alternatively, short sellers could be expecting the company to miss quarterly expectations. Last quarter, DigitalOcean posted earnings per share of $0.07 versus the consensus estimate of $0.12. Q2 results are set to be posted after the market closes on August 8, 2022.
Whatever it is the short sellers are looking at here, we think caution is warranted towards the stock. The high level of short interest suggests that there’s risk to the downside.