2 Heavily Shorted Stocks to Buy and 1 to Avoid

When a stock is heavily shorted, it can be a warning sign for investors. However, if these stocks defy expectations, short covering can be the launching pad for a strong run.

Let's look at two stocks with heavy short interest I'd consider buying: artificial intelligence (AI) voice company SoundHound AI (NASDAQ: SOUN) and luxury furniture brand RH (NYSE: RH). One I'd avoid is Super Micro Computer (NASDAQ: SMCI).

Consider buying SoundHound AI stock

With over 40% short interest, SoundHound AI is one of the most heavily shorted stocks in the market. Valuation could be one reason why, with the stock trading at a forward price-to-sales (P/S) multiple of 10 times 2027 analyst estimates. However, the bigger reason is likely its pending merger with LivePerson.

LivePerson is a distressed company with heavy debt, so the deal carries significant risks. However, SoundHound isn't paying a hefty price tag, and it could be a calculated risk worth taking. Meanwhile, it will seek to quickly retire LivePerson's discounted debt at deal close through a mix of cash and equity.

LivePerson will give SoundHound a large, established customer base to which it can upsell a more comprehensive solution based on its AI voice technology and agentic AI platform. Essentially, SoundHound is buying customer relationships and looking to incorporate its technology to enter the lucrative call center and customer service spaces.

While the shorts are eyeing a potential equity raise to pay off LivePerson's debt as a catalyst for the stock to decline, if SoundHound can stabilize churn and convert enterprises to its platform, the deal could become a home run that sends the stock significantly higher.

Consider buying RH stock

The home furnishing industry has struggled since the pandemic, and with RH aggressively expanding in Europe with lavish, expensive new stores, it is easy to see why RH is a popular short. However, the company's more than 30% short interest could be the rocket fuel to take this stock higher.

RH's CEO Gary Friedman is one of the most respected executives in the home furnishings industry. In addition to his bold bet on Europe, he is introducing one of the company's biggest brand extensions ever: RH Estates. This will be a more traditional furniture line, aimed at wealthy homeowners, and will include bespoke, custom-made collections for the ultra-wealthy and design professionals. This will be a high-margin business that Friedman believes could become RH's biggest growth driver in the coming years.

While investors are betting against RH, commentary from online furniture retailer Wayfair could be a good omen for the company. Wayfair recently came out and said its luxury furniture segment was booming, with its high-end Perigold brand seeing 35% revenue growth in the second quarter. If the high end of the furniture market is rebounding, RH could be a great way to play it, especially given its high short interest.

You may want to avoid Super Micro Computer

With a 15% short interest, Super Micro Computer is another heavily shorted stock, and it is one I would continue to avoid on the long side. The company actually gave a very strong update for its fiscal Q4, with its gross margins of 15% to 17% now projected to be much higher than its guidance of 8.2% to 8.4%. At the same time, revenue is soaring as it benefits from the AI infrastructure build-out.

However, at the end of the day, Supermicro is a low-margin middleman that continues to be clouded in controversy. With Nvidia and AMD moving more toward providing complete end-to-end servers, the little proprietary value that it gives should start to fade. Meanwhile, the company has a history of questionable accounting and run-ins with regulators. There are just better ways to play the AI infrastructure build-out, which is why I'd avoid the stock.

Geoffrey Seiler has positions in Advanced Micro Devices. The Motley Fool has positions in and recommends Advanced Micro Devices, Nvidia, and SoundHound AI. The Motley Fool recommends RH and Wayfair. The Motley Fool has a disclosure policy.