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5 Hated Stocks Primed for a Short Squeeze - views
BALTIMORE (Stockpickr) -- The short sellers are getting squeezed right now -- in a big way.
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. To exit their positions, short sellers have to buy back the stock they're betting against, adding extra buying pressure and forcing other short sellers out as well.
How high can a heavily shorted, hated stock get squeezed?
Well, electric car maker Tesla Motors (TSLA) is up more than 50% since Thursday, after better-than-expected profits sent short sellers covering their positions en masse. Sodastream International (SODA) is up around 20% over the same time for similar reasons.
And while those high-profile names have been catching the headlines lately, my research shows that some of the biggest returns come from buying the most valuable stocks on investors' hate lists.
When I say that investors "hate" a stock, I'm talking about its short interest. A stock with a high level of shorting indicates that there are a lot of people willing to bet on a decline in its share price -- and not many willing to buy. 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.
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 method 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 2013.
It's been a pretty tepid year for Salesforce.com (CRM). Shares of the $26 billion enterprise software company have only climbed 7% so far in 2013, falling well short of the S&P 500's hefty 15% return year-to-date. That underperformance is attracting short sellers this quarter, as Salesforce climbs up investors' hate list. At last count, the firm's short interest ratio rang in at 10.82, indicating that it would take more than two weeks of selling for shorts to exit their bets against CRM.
Salesforce.com makes a must-have application for its 100,000 customers. The firm's Web application lets users run business applications that interact with their customer lists, handling everything from sending newsletters to tracking sales. The Salesforce.com platform has a direct, measurable correlation to sales -- and that mission-critical nature of CRM's offering is digs a big economic moat for the firm.
Because CRM sells its software as a service hosted in "the cloud" rather than an application hosted on users' computers, it boasts an attractive subscription-based model. As a result, customers tend to be stickier because they've invested in the firm's platform; because integration takes place deep in the Salesforce platform, switching costs are extremely high for customers.
Earnings at the end of the month could be a big catalyst for this stock to get squeezed. Keep an eye on it.
Fastenal's (FAST) business may not be particularly exciting, but it's compelling, even if short sellers don't agree right now. FAST is an industrial supply company with more than 2,400 retail locations spread across the country. Industrial supply may be a bit on the boring side, but stair-step revenue growth and hefty double-digit net margins make it attractive to own.
Based on Fastenal's short interest ratio of 10.4, it would take more than two weeks of buying pressure at current volume levels for short sellers to stop betting against shares.
One of Fastenal's biggest benefits is its huge product catalog. The firm carries more than 410,000 types of fasteners and more than 585,000 maintenance and repair products, an inventory that makes Fastenal a one-stop shop for its customers. And because of its scale, the firm is better able to compete on cost and product availability than most of its smaller peers. Given the fragmented nature of the industrial distributor market, that's a big benefit indeed.
There's still a lot of growth in Fastenal's core market, especially as green sprouts start popping up on the industrial side of the economy. While the stock isn't exactly cheap right now, its growth pace and a spotless, debt-free balance sheet help to justify the firm's earnings multiple in this market.
On the other hand, it would be difficult to call Buffalo-based M&T Bank (MTB) anything but cheap. By most valuation measures, the $13.5 billion regional banking name enjoys a bargain price tag, even if its short interest ratio of 11.84 indicates that short sellers are still actively betting against the stock.
M&T Bank was a shining star during the financial crisis of 2008. While the firm got sold off alongside every other stock with "bank" in its name, its regional positioning meant that it maintained stricter underwriting policies heading into the housing crisis, and writeoffs were limited as a result. As recently as last year, M&T was charging off less than a quarter of what big banks were still determining to be worthless.
That financial strength has carried to shareholders' pocketbooks. With a 2.69% dividend yield, M&T tips the scales on the higher end of payouts from the financial sector. And while relatively low interest rates have made this environment a challenge for financial institutions such as MTB, the bank has been making up for it by increasing lending volume with that cheap money, particularly in its commercial loan book.
Earnings later this summer will give investors another glimpse at MTB's performance the numbers could be a catalyst for shorts to get squeezed out.
Green Mountain Coffee Roasters
Short sellers are getting shellacked on shares of Green Mountain Coffee Roasters (GMCR). While the firm seems to have perennially-high short interest, the 89% rally that shares have undergone year-to-date has certainly had an impact on their performance numbers. Now, with shares pushing through to new 52-week highs as recently as yesterday, short sellers have good reason to be nervous. Still, the firm's short interest ratio of 13.77 means that shorts are still making big bets that GMCR is due for a drop.
Green Mountain owns Keurig, the brand of beverage brewers that use self-contained K-Cups to make coffee, teas, and other drinks. While Keurig's "fad" status has certainly helped tip the deck against GMCR, the fact remains that the firm has done most of the hard work in getting Keurig machines accepted by consumers. With brewers essentially ubiquitous at this point, the firm is able to make money on its cash cow: the K-Cups.
K-Cups offer a sticky revenue stream for Green Mountain. Because they're proprietary, the firm can command premium pricing for them. And because the firm can offer new, diverse drink choices (like hot cocoa or iced coffee), it's able to drive sales among its large base. While investors have pointed to competition from the likes of Starbucks (SBUX) as a potential party-ender for GMCR, the renewed deal between the two firms is a big indication that SBUX's rival Verismo brewer isn't destroying Keurig's share of the market.
While GMCR is far from cheap right now, its hardly trading at an insane valuation given its growth trajectory and nearly debt-neutral balance sheet. Green Mountain may be a "fad stock," buy why wouldn't you want to own a stock that's enjoying fad momentum?
Digital Realty Trust
Last up is real estate investment trust Digital Realty Trust (DLR). With a short interest ratio of 15.7, it would take more than three weeks of buying pressure for short sellers to cover their bets against the firm. That makes DLR the most heavily-shorted name on our list today.
Digital Realty Trust is a REIT with a technology niche. It owns datacenters, Internet gateways and manufacturing facilities, nearly 100 properties comprising 16.8 square feet of leasable space in all. Because demand for datacenter capacity continues to grow (as technology like cloud computing becomes more and more popular), DLR has an added demand factor that most other landlord REITs simply don't. But don't think of this stock like a play on real estate. At its core, it's an income-generation tool.
DLR enters into long-term triple-net leases with tenants, an arrangement that takes most of the risks off of DLR's balance sheet and puts the onus on tenants instead. The result is a predictable income stream and a hefty 4.78% dividend yield right now. And because dividends are like kryptonite for short sellers, shorts need a higher level of conviction to hang onto a name that's paying out gobs of cash. That gives DLR significant squeeze potential this quarter.
To see these short squeezes in action, check out this week's 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, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.
Follow Jonas on Twitter @JonasElmerraji