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BALTIMORE (Stockpickr) -- With the end of 2012 just around the corner, fund managers are scrambling to make up lost ground between their performance and the S&P 500’s huge rally this year. Maybe they should be looking at the stocks that everyone else hates.
There’s still a lot of anxiety in the market right now -- more investor anxiety, in fact, than there was back in 2008 when stocks were in freefall. So despite the nearly 15% that the S&P has climbed this year, investors keep glancing towards the exits and missing out on more upside in equities. But there’s a way to catch up; it all comes down to being contrarian and buying the stocks that everyone else hates.
To be clear, I’m not a big fan of being contrarian for the sake of being contrarian. Instead, the data bear out this against-the-grain strategy.
Going back over the last decade, buying heavily shorted large and mid-cap stocks (the top two quartiles of all shortable stocks by market capitalization) would have beaten the S&P 500 by 9.28% each and every year. That’s some material outperformance during a decade when decent returns were very hard to come by.
It’s worth noting, though, that market cap matters a lot. Short sellers tend to be right about smaller names, with micro-caps delivering negative returns when the same strategy was used. Today, we’ll replicate the most lucrative side of this strategy with a look at five big-name stocks that short sellers are piled into right now. These stocks could be prime candidates for a short squeeze in the last quarter of 2012.
In case you’re not familiar with the term, a “short squeeze” is the buying frenzy that ensues when a heavily shorted stock starts to look attractive again to investors, causing share price to skyrocket. One of the best indicators of just how high a short-squeezed stock could go is the short interest ratio, which estimates the number of days it would take for short-sellers to cover their positions. The higher the short ratio, the higher the potential profits when the shorts get squeezed.
Naturally, these plays aren’t without their blemishes -- there’s a reason (economic or otherwise) that these stocks are being heavily shorted. But for investors looking for exposure to a speculative play with a beefier risk/reward tradeoff, these could be powerful upside plays for the coming year.
Without further ado, here’s a look at our list of large-cap short squeeze opportunities.
Laboratory Corporation of America
Up first on our list of most hated stocks is Laboratory Corporation of America (LH) -- LabCorp for short. This $9 billion firm is one of the largest independent medical lab operators in the U.S., with more than 1,700 patient service centers that provide everything from run-of-the-mill blood tests to more specialized genetic and oncology testing.
But investors hate this stock right now; short sellers have ratcheted LH’s short interest ratio up to 13.7, which means that it would take the better part of three weeks for shorts to buy enough shares of LabCorp to cover their bets.
LabCorp owns around 20% of the independent laboratory market, giving it scale in a business where size certainly matters. Let’s face it, medical testing isn’t exactly the most exciting business out there, and as a result, patients don’t care where they get their medical tests done. As long as the lab is covered by their insurance, location is the deciding factor. So, with a network that spans a bigger geographic footprint, LabCorp’s patient net is bigger.
Scale is also important in working out deals with medical providers on one side and insurers on the other. Because LH cuts a big swath, it can make more important deals with both groups.
The introduction of more complex testing products is a big deal for LabCorp – it opens the firm up to testing that yields much higher margins than the run-of-the-mill blood work can provide. As physicians opt for a fuller picture of a patient’s health, LH should be able to keep pushing its net margins into the double digits.
Earnings next week are still a big question mark, but for risk-hungry investors, the earnings call could be the big catalyst for shorts to start buying back shares.
When you drive by a truck that says Sysco (SYY) on the side, pay attention -- it may have your dinner in it. Sysco is the standard bearer in the food service distribution business, supplying everything from ingredients to par-cooked entrees to menu analysis services to 400,000 restaurants, hotels and institutional dining facilities.
Short sellers have lost their appetite for this stock, pushing its short interest ratio to 9.7, a level that indicates it would take two full weeks of buying at current volume levels for shorts to exit their positions.
Sysco is another example of the network effect in action. The firm’s focus on cost across its supply chain means that it can move products to its customers far cheaper than peers can, an advantage that boosts profitability and gives Sysco more pricing power. It also means that there are some pretty huge advantages in shoving more stuff on those trucks. Because the routes already exist, cross-selling more products and services to SYY’s existing customer Rolodex offers an easy way to earn growth.
To be sure, there are some risks in Sysco. The rising cost of soft commodities and trends toward locally sourced products at many restaurants are a couple of the headwinds that short sellers are latching onto. But Sysco’s financial performance has been rising steadily over the past few years, and a dividend hike looks likely in the next quarter. Those factors increase the possibility of a short squeeze in the near-term.
$10 billion auto parts firm Genuine Parts (GPC) is the firm behind the NAPA brand of automotive parts, distributing more than 400,000 parts to 5,000 stores spread across North America -- 1,000 of which are company-owned. NAPA also owns industrial and electronics businesses, wholesaling mission-critical parts for industrial equipment.
The business has a big target on its back right now; short sellers have bid the firm’s short interest ratio to 8.6.
GPC’s biggest business is NAPA auto parts at around half of sales. That exposure is especially attractive right now given the aging vehicle fleet in North America: at present, the average car on the road is older than ever before at 11 years. As consumers try to wring more time out of their existing vehicles, every firm involved in the process should benefit. An abundance of consumable products on its shelves also means that customers keep coming back.
Much like Sysco, GPC’s real claim to fame is its distribution network. Because the firm has built deep expertise at getting products to stores and customers quickly and cheaply, it has immense advantages over rivals who don’t have the same network effect.
Financially, GPC is in strong shape, with a cash balance that offsets around a third of the firm’s total debt. That, and impressive cash generation each quarter, should keep the firm’s hefty 3.2% dividend payout flowing for the foreseeable future. Oct. 18 earnings could be a big catalyst for upside that triggers a short squeeze.
Chemical manufacturer Sigma-Aldrich (SIAL) is one of the biggest names supplying chemicals and consumable products to scientific laboratories across the world. From pharmaceutical and biotech labs to academic labs to R&D testbeds, SIAL boasts more than 100,000 accounts.
Short sellers are piling into the stock right now. A short interest ratio of 12.3 means that it would take two and a half weeks of buying pressure for short sellers to cover their positions right now.
Sigma has built an attractive business selling chemicals and research materials. Because the firm’s products are typically a tiny fraction of research budgets, the folks signing the checks on those 100,000 accounts tend to be less concerned with price than quality. As a result, Sigma earns large net profit margins on its sales, dumping close to 20% of each dollar in revenues straight to the bottom line.
Investors should also like the fact that only a third of Sigma’s sales come from the U.S. With more and more research facilities opening up abroad, Sigma’s ability to capture sales in key emerging markets is critical to its ability to grow.
Sigma-Aldrich boasts a cash position that almost completely offsets its debt load right now, attractive positioning that gives SIAL the wherewithal to continue pushing its distribution network into emerging markets where science spending is a priority. Investors should keep an eye on this stock’s Oct. 23 earnings call.
United Continental Holdings
The best thing United Continental Holdings (UAL) has going for it right now is the fact that it’s not American Airlines.
UAL is the largest airline in the country, post-merger United operates approximately 6,000 flights each day from what’s arguably the most attractive hub network in the country. The firm gained its current shape back in 2010 when United merged with Continental to combine forces and cut costs, and the early indications show that the firm is doing just that.
The UAL merger didn’t come without turbulence, and the combination of excessive combination costs and operational hiccups certainly didn’t help instill investor confidence right after the deal closed. But the fact that UAL is keeping its bottom line in the black is promising, especially in the economic conditions we’re in right now.
To be clear, UAL isn’t the best-in-breed legacy airline stock -- Delta Air Lines (DAL) is. But Delta’s stock price doesn’t sport the same level of antipathy that United’s does. Right now, short sellers have pushed UAL’s short interest ratio up to 10, a level that indicates it would take two full weeks of buying at current volume levels for shorts to exit their trades. That puts UAL’s stock in potential short squeeze territory.
Critical screw-ups at rival American are likely to help push a disproportionate share of traffic to United this Fall -- something investors will see reported in UAL’s financials sooner rather than later.
To see this week’s short squeezes in action, check out the of Large-Cap Short Squeezes portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji, based out of Baltimore, is the editor and portfolio manager of the Rhino Stock Report, a free investment advisory that returned 15% in 2008. He is a contributor to numerous financial outlets, including Forbes and Investopedia, and has been featured in Investor's Business Daily, in Consumer's Digest and on MSNBC.com.