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BALTIMORE (Stockpickr) -- I hope you’re not a short seller.
If you are, you’ve probably gotten your hat handed to you in the last couple of months as the broad market ratcheted higher and investors’ confidence in stocks strengthened. As I write, the S&P 500 has climbed more than 10% year-to-date. For shorts, that’s a pretty nasty trend to try to bet against.
The argument to short a company can be compelling: from the economic collapse that’s barely out of short-term memory for most market participants to individual factors like overleveraged balance sheets or unprofitable business models, there’s no doubt that betting to the downside can generate gains in market conditions when few other strategies can. But when the market is roaring, short sellers can find themselves in a world of hurt.
And that exact scenario is creating a major short squeeze opportunity in a handful of momentum stock names this week.
An uptrend is like kryptonite to short sellers. Unlike long positions, where owners can hold onto losers for as long as they like, excessive uptrends can cause short sellers to get a margin call (effectively a forced stop-out unless they’re willing to pony up more capital). That factor means that uptrending names can fuel even bigger short squeezes than their stagnant peers.
Let’s back up for a second. 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 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 uptrending short-squeeze opportunities.
Genetic analysis firm Illumina (ILMN) has certainly been trending higher lately. The firm has seen its shares rally more than 65% since the first trading day of 2012.
But that performance hasn’t kept the shorts at bay; with a short interest ratio of 10.1, it would take more than two full weeks of buying at current volume levels for shorts to cover their positions. That makes Illumina a prime candidate for a squeeze in 2012.
Illumina makes the tools and equipment used to study genetic material. That business has seen some significant tailwinds in the last couple of years, thanks to increased focus on genetic therapies in the pharmaceutical arena. If pharma firms (or acadmics) want to perform gene expression or genotyping, they’ve got to turn to ILMN’s equipment to do it.
The trajectory of ILMN’s share price has made it a major target for shorts who want to bet that ILMN’s growth is overblown, but that same uptrend is making it painful for shorts to hold onto their positions right now.
Financially, Illumina is in stellar shape, with more cash than debt and strong margins. Illumina may not be a “cheap” stock in the conventional sense, but it’s a deep growth name that actually has some fundamentals behind it. Another quarter of top-line growth could fuel another buying spurt.
Illumina shows up on a list of 15 Best Stocks at Top-Performing Mutual Funds.
Mindray Medical International
Chinese medical device maker Mindray Medical International (MR) is the cost leader in the medical device market. While that wouldn’t normally sound like a good thing, it is one when it comes to emerging markets like China where the decision to bring advanced Western medical tech is very cost driven. For that reason, Mindray has established itself with the biggest share of China’s lucrative medical device market.
Mindray has historically focused on smaller customers -- the doctor in rural China has very different needs in his tools than one in a modern Beijing hospital. By serving the rural and mid-market, Mindray has put itself in a position where it can competitively develop more advanced offerings for its fast-growing international segment.
A nearly debt-free balance sheet and hefty cash position are a couple of the contributing factors to the 29% rally shares have seen YTD. They should also help to more quickly dissipate the firm’s short interest ratio of 19.3; it’s hard to sustain a bet against a stock with close to 20% of its market-cap covered with cash.
As of the most recently reported period, Mindray is one of the holdings of Eric Mindich's Eton Park Capital.
Communications device maker Harris (HRS) has enjoyed an uptrend of its own this year. Since the first trading day of January, this mid-cap stock has seen the value of its shares increase by 21.3%. Harris’ bread and butter is the radio business -- the firm’s radios are used by everyone from the troops in Iraq to oilrig workers calling home on advanced VSAT terminals.
Historically, Uncle Sam has been the lion’s share of Harris’ business. Last year, for example, the U.S. government made up more than 70% of total revenues. For that reason, defense spending cuts have been one of the biggest black clouds short sellers have clung to for their investment theses. But the mission-critical nature of the secure radios Harris makes should help the firm avoid the brunt of any cuts.
So should the firm’s positioning . With a massive market in law enforcement and fire radios, as well as an attractive commercial market, there are still plenty of places to look for ways to make up any sales shortfalls.
It also helps that the firm is in solid financial shape. With ample wherewithal to ride out any short-term hiccups, investors don’t need to worry about liquidity. The firm’s short interest ratio of 14.8 means that it would take almost three weeks of buying for shorts to get out of their HRS positions. That could easily set the stage for a squeeze in the near-term.
Harris shows up on a list of 10 High-Quality Stocks for 2012.
Auto parts maker BorgWarner (BWA) may be the reason your car is on the road today, even if you’ve never heard its name. The firm supplies engine and drivetrain components like turbochargers, timing belts, and transmissions for a huge group of automakers. Customers include Volkswagen, Ford and Daimler -- names that have been surging in 2012 as new vehicle sales show strength.
BorgWarner has been surging too. The firm’s year-to-date performance weighs in at 30.35%.
BorgWarner enjoys massive scale and niche offerings, a killer combination that results in a sticky customer base of some of the largest carmakers in the world. The firm’s technology is also a major selling point right now. BWA specializes in engine components that enable vehicles to run more smoothly and less expensively, a critical offering in the age of $4 gasoline. As proprietary technologies from BWA gain popularity, the company may also be able to court new carmakers more effectively.
Sales and net margins have both been expanding in the last couple of years, offering investors a two-pronged approach to bottom-line growth. Although car part manufacturing is a capital intense business, BWA maintains strong financial health, and relatively little debt.
Those factors haven’t spared the firm from shorting, though. BorgWarner’s short ratio at 15.4 means that it would take three full weeks of buying pressure at current volume levels for shorts to unwind their bets.
That high number means that a short squeeze is a real possibility if late April’s first quarter numbers impress Wall Street.
Wesco International (WCC) is another international industrial name that’s been subject to heavy shorting lately. The firm sports a short interest ratio of 11.7 despite the 21.5% rally shareholders have enjoyed year-to-date in 2012.
Wesco distributes electrical components to customers in the construction, industrial, and utility businesses. Thanks to some pretty serious economic headwinds, the industrial distribution industry has been a perennial short target in the last couple of years. But Wesco is one of the few names that have still got a lot of short interest in 2012. That helps to make this stock a special situation right now.
Recent shifts in Wesco’s catalog have helped the firm eclipse its pre-recession sales numbers as an increasing chunk of sales started coming from selling communications components. Currently, scale is one of the few advantages that industrial distributors have -- and while Wesco’s scale puts it on par with a few other major rivals, it lacks a moat. Specialty part procurement for communications customers could change that.
In the meantime, this rally is should be making shorts question their positions in WCC.
To see this week’s short squeezes in action, check out the Uptrending Stocks Short Squeeze 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.