Stock Market

Clover Health Might Drag Due to the ‘Free Lunch’ Problem

Presumably, most of us as children have had at least one experience where we joyously marveled at the concept of giveaway events, only to have our parents teach us that there’s no such thing as a free lunch: somebody always pays. Clover Health (NASDAQ:CLOV) is an excellent reminder of this truism. While CLOV stock appeals to our heartstrings, the economics still matter.

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As the company proudly proclaims on its website, “Clover Health is Medicare done differently.” A specialist health insurance provider which offers low-to-zero cost premiums combined with low co-pays and prescription drug costs, the company is a godsend for those seeking affordable healthcare solutions. Although I can’t prove it, I believe this sentiment of providing positive services to the public emboldens CLOV stock bulls in their battle against the bears.

If you think about it, you can see why this narrative is so appealing. I mean, what kind of monster would want to short a company that’s providing grandma with her arthritis medicine for a dollar or two less? Further, the morality play in other meme stocks is evident, with many folks jumping on the bandwagon because they remembered the pain the Great Recession caused their parents. This is a way for the little guys to get back at Wall Street.

So, it wouldn’t be surprising that the same sentiment drives CLOV stock. In fact, social media-based hype drove shares higher previously, so the concept isn’t anything new. Essentially, if the bears are shorting it, CLOV bulls will go long, attempting to spark a short squeeze.

I’ve discussed the mechanics of the short-squeeze tactic a few times before but the basic idea is that bears potentially face unlimited risk since there’s no limit to how high a stock can go. By taking the opposite trade, speculators can make substantial profits — but by no means is this a guarantee.

CLOV Stock Is Running Itself Dry

Another aphorism that we all learned as kids is if something is too good to be true, it usually is. Regarding CLOV stock, just jumping onto the long side of a heavily shorted security doesn’t guarantee profitability. Heck, it doesn’t even guarantee hurting the Wall Street hedge funds that are in everyone’s crosshairs lately.

If it were that easy to be a successful trader, everybody would do it. You know all those trading books and subscription services? Yeah, they wouldn’t exist because you can fit the directive on a Post-it Note (and I’m talking about the miniature variety): When they go short, you go long.

Unfortunately, it’s not that easy. With CLOV stock, you should really consult the underlying company’s own documents — the primary source if you will — before making a decision.

Interestingly, in Clover Health’s Form 10-Q filing with the Securities and Exchange Commission, the company cites its key strength as follows:

We call our plans “Obvious” because we believe they are highly affordable — offering most of our members the lowest average out-of-pocket costs for primary care physician (“PCP”) co-pays, specialist co-pays, drug deductibles and drug costs in their markets—and provide wide network access and the same cost-sharing (co-pays and deductibles) for physicians who are in- and out-of-network. By empowering physicians with data-driven, personalized insights at the point of care through our software platform, we believe we can improve clinical decision-making and viably offer these “Obvious” plans at scale, through an asset-light approach.

Certainly, it’s obvious why someone would choose Clover Health. Money doesn’t fall out of the sky and controlling costs is vital when you’re living on a fixed income. However, somebody has to provide this service — and Clover isn’t doing a great job of it… or, at least in managing the costs of providing it.

Over the last year-and-a-half, the company’s operating losses have been widening despite increasing memberships, which is something that seasoned investors will watch closely.

Sometimes, Shorted Stocks Are That Way for a Reason

While the optics of people shorting health insurance providers — particularly for those on Medicare — are understandably unsavory, I think prospective bullish speculators should consider the bigger picture. At some point, if Clover doesn’t generate profits, the business will fail. And grandma will have to look for another solution then.

In a way, bears are the great white sharks of the market. While the media focuses on the titillating narrative of shark attacks, these apex predators’ main job is to control maritime ecology, primarily through eating sick and dying sea life. Without them, the balance of life in the deep waters would be completely out of whack, potentially causing problems for everything else.

That’s what is going on with CLOV stock. Obviously, I can’t say for certain that Clover Health is an ailing company. But that’s what the bears are speculating on — and they have every right to do so, just like you have the right to think and act differently.

Therefore, it’s better to throw away the morality argument because it clouds the main point. It boils down to which side has the better argument. Unless management has an answer to the free lunch problem, it’s hard to argue against the bears’ reasoning.

On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.