Stock Quotes in this Article: DLR, ECL, GRMN, IDXX, SHLD

 BALTIMORE (Stockpickr) -- When it comes to catalysts for stocks to move, there’s nothing quite like earnings season. Good earnings can send shares rallying double-digits. At the same time, a bad turnout in earnings data can shove shares down by a similar amount. It’s that extra earnings-surprise-induced volatility that makes this now such a perfect time for a short squeeze.

We’re still in the early stages of earnings season (the “official” kickoff was last week), but the indications are good so far. Of the roughly 10% of the S&P 500 Index that’s already reported, around 70% have posted positive earnings surprises. That suggests that Wall Street is underestimating average corporate earnings this quarter.

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    This week, we’re looking to take advantage of mispricing in heavily shorted stocks ahead of their earnings releases. After all, the added buying pressure of good earnings adds significant spark to any potential short squeeze name.

    Let me back up a bit. Put simply, 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 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.

    With that, here’s a look at five earnings season stocks that look like prime short-squeeze candidates right now.

     

    Garmin

    With a short interest ratio of 22.44, Garmin (GRMN) is the most heavily shorted name on today’s list. For perspective, that number means that it would take more than a full month of buying pressure for short-sellers to exit their positions at current volume levels -- that’s a lot of short interest.

    Garmin is best-known for its GPS devices -- the firm develops and sells everything from in-car GPS units to next-generation glass cockpits for aircraft. While the firm’s navigation devices are extremely popular, a slowdown in the firm’s automobile segment has investors anxious. Garmin’s best bet is to move away from the commodity-like state of current nav devices, and push toward leveraging its massive R&D expertise to bring some of the more impressive aviation and marine developments to the consumer market.

    While Garmin’s core market is challenging right now, shorting in this stock is overblown. Financially, this stock is in a rock-solid position with approximately $2.5 billion in cash and long-term investments and no debt. That cash position makes up almost half of the company’s market cap right now -- and it helps to reduce uncertainty over its 4.62% dividend payout. (Garmin is one of the top-yielding electronics stocks.)

    >>6 Dividend Stocks for Earnings Season

    That level of financial wherewithal means that Garmin can afford to push into novel markets with its products going forward. In the meantime, an expected earnings date of Nov. 2 could be the spark that shares need to scare shorts into a buying frenzy.

    Ecolab

    Ecolab (ECL) is one of the biggest names in the cleaning and sanitation business, serving the needs of the institutional and commercial maintenance departments across the globe. The firm’s reach is one of its biggest attributes -- because Ecolab is the standard bearer for the industry, it’s able to capture favorable deals on reputation alone. But that hasn’t kept short sellers from betting against this stock; Ecolab currently has a short ratio of 10.29.

    Because Ecolab employs an aggressive internal sales team, the firm is able to retain bigger margins and stickier sales than competitors who sell through larger distributors. While those distributors have inherent advantages in their “one-stop shop” model, they clearly haven’t been enough to dissuade customers from buying directly from Ecolab. The firm’s share of the market proves that.

    I suspect that at least part of the heavy shorting in Ecolab is merger arbitrage over the firm’s proposed acquisition of Nalco (NLC) if that’s the case, the implication is that there will be considerable short covering near year-end as those investors wind down their merger trade. On a shorter-term timeframe, earnings on Oct. 25 could be a strong catalyst for bandwagon shorts to flee on a rally.

    Ecolab is one of The 2011 Dividend Aristocrats, having increased its dividend for at least 25 years.

    Digital Realty Trust

    Frankly, heavy shorting in Digital Realty Trust (DLR) is more likely to be a case of mistaken identity than anything else. There are still plenty of investors who think that this real estate investment trust is a play on the commercial real estate market, but it’s not. Instead, this income-generation tool has several layers of insulation from real estate values. Let me explain.

    Digital Realty Trust is a REIT that owns datacenter locations throughout the country. Datacenters are in high demand right now, as new trends in cloud computing and internet-enabled mobile devices strain the abilities of the country’s current networks. That secular demand is one good reason why DLR isn’t subject to the typical ebb and flow of the real estate market; its niche properties are too specialized.

    Another reason (as with most REITs) is the firm’s use of long-term, triple-net leases with tenants. Those leases mean that DLR isn’t on the hook for any maintenance costs or property taxes -- the tenant pays for all of that, and pays DLR a set, consistent rent (with built-in inflation increases).

    At this point, I think that some short-sellers are also attracted by this firm’s dividend payout -- at 4.6%, a dividend reduction could be a good catalyst for shares to fall. But they’re ignoring the fact that REITs are designed to be dividend machines. They don’t pay taxes on their distributions, and their insulation from market conditions means that they can continue to operate without too much impact from outside challenges.

    At present, Digital Realty Trust has a short interest of 10.29. Expect to see earnings on Oct. 27.

    I also featured Digital Realty, one of the top holdings at Ken Heebner's Capital Growth Management, last week in "6 Crash Stocks to Buy Now."

    Idexx Labs

    $4 billion medical equipment maker Idexx Labs (IDXX) isn’t your typical medical device stock. That’s because the devices that the firm develops and manufactures are veterinary products for pets and livestock: its biggest products include diagnostic testing kits and veterinary pharmaceuticals. Right now Idexx is sporting a short interest ratio of 10.35, which indicates that it would take short sellers two full weeks of buying to cover their positions at current volume levels.

    Bringing new products to market quickly has been one of Idexx’s biggest benefits in recent years. By staying at the cutting edge, Idexx is better able to attract veterinary practices that are looking for medical products that provide faster results and better treatments. The majority of Idexx’s products are relatively high margin; as a result, the company currently enjoys net margins in excess of 15%.

    From a financial perspective, Idexx is in solid shape. The firm carries a meaningless amount of debt that’s more than offset by a $160 million cash position. Investors should keep an eye out for earnings on Oct. 21.

    Idexx is one of TheStreet Ratings' top-rated health care equipment stocks.

    Sears Holdings

    Last up is Sears Holdings (SHLD), a stock that’s probably the most controversial name on this list. Sears has struggled continually to turn around its ailing business -- thus far, the company’s proven unable to make any meaningful stabs at growth. Size is one of Sears’ biggest liabilities right now. Because the firm’s footprint is unwieldy, it’s incredibly challenging to reduce costs and built revenues across all of its businesses. That said, there are some attractive attributes about this name.

    Sears still boasts significant brand presence in the U.S., even if the acquisition of Kmart in 2005 hasn’t exactly panned out as planned. Most attractive is the firm’s portfolio of brands -- including Kenmore, Craftsman and Die Hard. Sears’ management has finally been working to leverage those brands outside of the company’s eponymous stores. New sales channels for those products are a potential game changer for Sears.

    To be clear, this name isn’t a particularly attractive buy-and-hold option at this time, but as a potential short squeeze play, it could fare very well. It’ll be crucial to watch the market’s reaction to earnings on Nov. 18. At present, Sears’ short interest ratio weighs in at 16.82.

    Sears, one of Bruce Berkowtiz's top holdings, shows up on a recent list of 3 Iconic Companies on the Brink.

    To see this week’s short squeezes in action, check out the Earnings Season Short Squeezes portfolio on Stockpickr.

    -- Written by Jonas Elmerraji in Baltimore.

    RELATED LINKS:

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    >>5 Rocket Stocks for Earnings Season

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    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.