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PALM, trading day 21 August, 2009

Many expected that following last week’s pleasant cross-market rally that Monday would open with a thud. Thankfully for the portfolios of traders and investors alike, the markets just sort of stumbled today, with the Dow Jones Industrial Average down half a percent and the NASDAQ up a quarter percent. But the remarkable story of the day was Palm (PALM), which surged after 2:30 pm 13.85%, closing the day at $15.95 (after opening at $13.77).

So what drove today’s $1.94 jump in Palm’s share value? It depends on who you ask. TheStreet.com says that the rally was caused by what’s called a ‘short squeeze.’ Traders today have the ability to perform transactions called ‘shorting,’ where they borrow a stock and sell it, with the expectation that the stock price will drop in the near future. Once the price drops, the trader buys the stock back and returns it to the entity that lent the stock.

Essentially, it allows for trading without ever really owning the stock. A short squeeze occurs when a stock has been heavily shorted (many large institutional traders have shorted the stock) and traders are competing for a scarce supply of the stock. In the case of Palm, the shares were heavily shorted going into last week’s earnings report, which did not disappoint as many analysts had expected. With so many traders creating a large demand for Palm, the share price increased to reflect the demand and scarce supply.

The short squeeze isn’t the only thing that may have set Palm back on the path to $16. Jim Cramer, host of CNBC’s Mad Money (Cramer also owns the above cited TheStreet.com) went onto CNBC’s Stop Trading to talk about what he calls the “mobile internet tsunami,” which he predicts will lift smartphone makers, chip suppliers, and network infrastructure builders to new heights in coming years as smartphones experience what is expected to be incredible growth.

This market expansion is what Palm’s bid for renewed relevance is based on - they intent to exploit new niches in the smartphone market instead of muscling into the space occupied by the iPhone and BlackBerry devices. Say what you will about Jim Cramer, but the man’s word carries some weight with a lot of investors, and those investors were listening today when Cramer said, “This tsunami of the mobile internet is so big that there’s room for Palm, room for RIMM (Research in Motion), and room for Apple. A lot of people thought that Palm’s quarter wasn’t any good last week. If they hadn’t filed a secondary I think this stock would be a $16-$17. I couldn’t believe the sold 800,000 Pres without any real software.” Believe it.

[ sorry Pre readers, not youtube ]

So, about that secondary. When Palm took the shroud off the numbers last week, they also announced an upcoming secondary offering, where Palm will be putting out an additionally 16 million shares. It is expected that Palm will set pricing for the offering tomorrow, which will be based on market pricing. It is common in the event of this type of secondary offering (the market-priced variety) for large investors in the company to make additional purchases prior to the offering to create more demand for the stock and raise the secondary offering’s price, therefore netting more cash for the company in which they have an interest. That’s not to say that this is or isn’t the case with today’s stupendous rally in Palm’s stock, but those with a vested interest in Palm’s welfare would be wise to have done so. While it is an admittedly shady and manipulative practice, it’s perfectly legal (all the investor is doing is buying more stock, nothing wrong with that).

So where do we go from here? Well, immediately after the closing bell rang Palm has waffled slightly in extended trading. Is a new 52-week high in sight for Palm? Not likely. Once the secondary offering hits you can expect that PALM will drop again (more supply + steady demand = lower prices), but it will be the coming quarter that will determine Palm’s future. Right now, given Palm’s cash situation and sales numbers, the stock is still greatly overvalued. While Palm did offer lower guidance on the conference call than analysts expected, it’s up to the company to outperform both its own guidance and market expectations. Then, and only then, can Palm trade on the level of Research in Motion and Apple.