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5 Unloved Stocks to Crush the S&P - views
BALTIMORE (Stockpickr) -- You should be buying the stocks that everyone hates right now. In fact, you should be buying the biggest, most hated stocks with both hands this summer.
Why? The research shows that it pays to be contrarian.
I’ve argued for a long time that it makes sense to look at big, financially secure stocks with hefty short interest. After all, piles of shorts in a good name have a very big possibility of getting squeezed and driving share prices higher for the folks on the other side of the trade. But that’s not just an opinion -- the data bear that strategy out as well.
Taking a look at 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.
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.
First up is AvalonBay Communities (AVB), a $13.7 billion real estate investment trust that owns close to 50,000 apartments spread across major metropolitan areas from New York to San Francisco. By focusing its portfolio on pricey, in-demand geographic areas, AVB is a more attractive offering than many of its peers, particularly now, when homebuyers are more anxious about dropping a mountain of cash on a home in a pricey region. A strong rental market in AvalonBay’s key markets has been boding well for shares of late.
AVB doesn’t have the same characteristics that you’d find in a commercial REIT -- super long-term leases and maintenance paid for by the tenant are out of the question, for instance -- but the firm has still managed to churn out a respectable income payout. At their core, after all, REITs are essentially purpose-built income-generation vehicles. AVB’s attractive positioning helps make it the best-in-breed among housing REITs.
Not everyone agrees, of course. The firm’s short interest ratio of 10.4 indicates that it would take more than two full weeks of buying pressure at current levels for short sellers to cover their bets against AVB. That hefty pressure against the stock makes it a prime short squeeze candidate; with shares trending higher over the last couple of years, shorts are probably already feeling the pain.
Garmin (GRMN) is one of those stocks that seems crazy to go short against. The firm boasts huge profitability, no debt, more than $2.5 billion in cash and investments (paying for around 30% of its market cap right now) and a huge 4.3% dividend payout.
But shorts are betting that increasing competition in the GPS business will torpedo those stellar financials and send the stock sinking. That’s why Garmin currently has a short interest ratio of 18.7, indicating that it would take almost a month for shorts to cover their bets.
It’s true that consumer GPS devices aren’t a very attractive business anymore. Units are becoming commoditized, margins are dropping, and other devices (such as cellular phones) are taking their place as navigators. But if anyone can shake the industry headwinds, it’s Garmin. For starters, the firm still earns hefty margins on automotive GPS units, as well as an impressive share of other lucrative markets for GPS: Outdoors, boating and aviation are just a few. Ask any pilot who owns the navigation market in general aviation (or look at the firm’s amazing $50,000 G1000 avionics suites), and Garmin is the clear winner.
Exposure to those other high profit, low volume markets enable Garmin to pour R&D into big-ticket electronics and then transition the tech to the more margin-sensitive consumer market. While the breakneck growth of consumer GPS is effectively over, Garmin’s business model isn’t.
Cellular tower stock SBA Communications (SBAC) owns a chunk of the mobile infrastructure spread throughout North and Central America. By leasing antenna space to wireless carriers, the firm has built a business that others dream of: It’s chock full of recurring revenues, it’s recession-resistant, and more capacity is very much in demand right now. But that hasn’t kept shorts from hiking SBAC’s short interest ratio up to 10.8.
SBAC gives carriers a way to increase the number of bars subscribers get without increasing their debt loads -- building a cellular network is capital-intense to say the least. But SBAC’s growth has been staid and measured, keeping its balance sheet manageable as the firm expands in size.
The biggest tailwind for SBA Communications right now is demand. The proliferation of smart phones has greatly increased the bandwidth needs of cellular operators, driving up the number of sites that SBAC can build and economically justify. Because the firm is the smallest tower operator of the big three, it’s got ample room to stretch out its network footprint.
Financially, SBAC is in solid shape. Obviously, the cell tower business isn’t cheap, and it’s no surprise that this firm has financed its network primarily with debt. But the debt load is more than manageable, especially given the prolonged low interest rates that firms are enjoying right now. As SBAC continues to throw off cash (and buyback shares and pay down debt), the short case is going to be harder to keep going.
The standard bearer in the UK cable TV market, Virgin Media (VMED) provides service that serves close to two-thirds of the country’s population. Like SBAC, Virgin Media’s entire value proposition (both to investors and to customers) lies in its network infrastructure. As a relative newcomer in the space, the firm boasts a modern network that delivers faster speeds for broadband internet than most rivals can offer. That’s secured it the country’s number-two spots in pay TV and internet service.
On the flip side, Virgin has financed that speedy network through debt. VMED is one stock where the debt load is truly substantial relative to its size – but the cash that the cable network throws off should easily cover it provided that VMED doesn’t suffer a mass customer exodus in the next few quarters. A debt restructuring pushed maturities way back for the firm as well, removing the biggest liquidity concerns from investors’ shoulders.
But the stocks’ short interest ratio of 11.8 means that short sellers are still betting against VMED en masse. That makes this stock a solid short squeeze candidate for 2012.
As of the most recently reported quarter, VMED was one of David Einhorn's Greenlight Capital holdings.
Alliance Data Systems
Alliance Data Systems (ADS) is all about customers – their customers’ customers, that is. The firm provides marketing and loyalty services for other companies, handling more than 120 million customer relationships with a specific focus on Canada, where its Air Miles subsidiary operates. From gas stations to airlines to banks, Alliance Data is all about outsourced customer relationships.
That’s proven to be a lucrative business for ADS. The firm earns double-digit net margins for its trouble, while at the same time building itself an attractive moat. With clients’ customer lists and very long-term contracts as standard, revenues are stickier than they would be if ADS didn’t own many of the networks that it administers for firms. ADS has also established itself as a major player in the private-label credit card business, processing transactions on behalf of retailers who don’t want the hassle or balance sheet risks of issuing cards themselves (for its part, ADS securitizes its receivables, so little credit risk remains on its balance sheet).
ADS currently sports a short interest ratio of 13.7, which means that it would take short sellers close to three weeks to cover their positions. That puts this $6.7 billion firm directly in line with our market-beating strategy this summer.
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.