JetBlue's ( JBLU) megagrowth story has been so wildly popular that the upstart has replaced tried-and-true Southwest Airlines ( LUV) as the most popular low-cost carrier among investors. But a look at short interest in JetBlue points to some risks.

After New York-based JetBlue said during its first-ever shareholder meeting on May 21 that it expected annual growth exceeding 55% in 2003, equity analysts became more bullish on the stock, despite its lofty valuation. Over the last two weeks, UBS Warburg and Standard & Poor's have upgraded shares, while Bear Stearns reiterated its positive outlook, saying the company deserves to trade at a premium to its peers.

Sixty percent of analysts rate JetBlue a buy, twice the number who rate Southwest a buy. But while most analysts prefer JetBlue's story, the level of short interest reveals that many believe the company could be a riskier proposition than Southwest. Short interest against JetBlue shares -- a bet that the company's stock price will fall -- far outweighed that of its rival, even though Southwest had a higher valuation.

According to the most recent data from Bloomberg, 12.3% of JetBlue's shares were shorted through May 8, while just 1.6% of Southwest's shares were shorted, lowest among any of the airlines. And even though Southwest's price-to-earnings multiple had jumped from 52 to 67 in the two months leading up to May -- a sign the stock could be getting too pricey -- the level of short interest actually fell.

Experts believe the rising level of short interest in JetBlue shares could be a complicated hedge by those who are long Southwest -- or it could be a bet that JetBlue is overvalued at current levels.

"Hedge funds engage in some very sophisticated strategies, so the short may not be reflection that the company is bad," said Tom Taulli, author of TheStreetSmart Guide to Short Selling . "But another reason is that people do think that JetBlue is overvalued. That tends to be harbinger of things to come, seeing short interest like that. On balance, it's probably a negative."

Risky, but Rewarding Too

However, short interest works two ways, since a rising stock can trigger a short squeeze, in which people who have shorted the stock are forced to cover their bets with stock at higher and higher prices. Although a sign of risk, shorting also increases the potential rewards, with unexpected good news triggering an explosive upside move.

While predicting short squeezes is impossible, there are certain characteristics that make it more likely -- and JetBlue exhibits many of them. For starters, the company has an extremely small float, or number of shares available for purchase, and that makes it harder to cover a short position. JetBlue's float is just 47.9 million shares, a puny fraction of Southwest's float of 768.1 million shares.

By comparing the average daily volume in a company's stock with the number of shares that are short, you can figure out the short interest ratio -- or the number of days it will hypothetically take to cover the short position. The higher the number, the longer it will take to cover the short and the greater potential for a short squeeze.

Of all the airline stocks, none have greater potential for this kind of big upside move than JetBlue. According to Bloomberg, JetBlue's days to cover stood at 8.9 through the beginning of May, well above Southwest's 5.1 and higher than any other carrier.

"The positive part comes when you have the days to cover getting long in the tooth; it could result in short squeeze," said Taulli. "If there's unexpected good news, the stock spikes, and shorts rush to exit. So, kind of rule of thumb, you don't want more than week of days to cover on short, because that could be ammo for a squeeze."

The action in AMR ( AMR), parent of American Airlines, provides a good illustration of how this can pay off. According to Bloomberg, in early March, as the fears the company would be going bankrupt were peaking, AMR's days to cover stood at 10.6. Over the next two months, through May 8, the bankruptcy fears vanished, daily volume jumped, the stock gained 166% and the days to cover fell to 2.1.

The Long and Short of It

While Wall Street analysts remain bullish on JetBlue, Taulli says that long-term equity investors should keep an eye on short interest, if only because short-sellers are putting their money where their doubt is.

"I would still bet against the analysts," said Taulli. "I think the short-sellers are better than Wall Street equity analysts, because they have to be. When you lose, you lose big. They do a lot of research and analysis because there are so many risks. You have to be really good."

But in the near term, there are signs that the shorts are wrong on JetBlue, with trading in recent days indicating the squeeze is already on, according to Ken Wolff, columnist for RealMoney.com and founder of MTrader.com.

"If you look at JetBlue's last high near $36, that's where shorts are betting the stock will fall, and if it reaches $35.50, or even $35, you'll see some real momentum coming in," said Wolff. "Other shorts are already hurting, though. They're getting whipped right now. I'm sure you're already seeing covering, because it pulled back where the market hasn't. And if we see JetBlue go to $35, then we could see $36, $37 or $38. And the squeeze will cause that."

On Monday, JetBlue shares rose 45 cents, or 1.3%, to $34.33. Southwest rose 22 cents, or 1.4%, to $16.28.
TheStreet.com has a revenue-sharing relationship with Amazon.com under which it receives a portion of the revenue from Amazon purchases by customers directed there from TheStreet.com.

If you liked this article you might like

Check the Math on Air Fares

Check the Math on Air Fares

US Airways Circles as Pilots Bicker

US Airways Circles as Pilots Bicker

Departure of Delta's Song Unit Boss Stirs Questions

Departure of Delta's Song Unit Boss Stirs Questions

Boeing Boosts Jet Deliveries

Boeing Boosts Jet Deliveries

CEO Gilmartin Will Survive Recall

CEO Gilmartin Will Survive Recall