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Beat the S&P With 5 Stocks Wall Street Hates - views
BALTIMORE (Stockpickr) -- It may not feel like it right now, but by and large, investors still hate stocks.
The S&P 500's biggest one-week gain of the year last week? Investors hate it.
The 17.5% that the big index has managed to climb year to date? They hate that too.
The whopping 145% rally since the S&P bottomed back in March 2009? They hate that most of all.
The fact is that today, only 52% of U.S. adults are invested in the stock market, according to research done by Gallup. That's the lowest level recorded since the poll was first published in 1998. It's not just Main Street either. On average, Wall Street strategists are still extremely bearish in 2013.
But all of that hate can be harnessed for your advantage this summer. All you have to do is hone in on thefive biggest stocks that investors hate the most.
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. Too much hate can spur a short squeeze, a buying frenzy that's triggered by shorts who need to cover their losing bets. And with the rally we've been in of late, you can probably guess that there are lots of losing short bets.
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.
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.
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.
First up is Ecopetrol (EC), the $91 billion Colombian oil and gas company. The Bogota-based firm is the biggest energy company in Colombia, generating around 70% of the country's energy output. The Columbian government owns around 90% of Ecopetrol; investors own the rest.
In a lot of ways, Ecopetrol is your typical national oil firm. The company is very integrated, from exploration and production to refining and transportation. Having a major partner in the government comes with some big advantages for Ecopetrol, especially when it comes to securing rights to Colombian oil and gas properties. The flip side to that relationship comes from the relatively unstable nature of Colombia's political system -- the threat of sudden nationalization of EC means that there's a discount priced into shares. Between geopolitics and exposure to the Colombian Peso, it's no surprise that investors hate it, but its size makes it a key short squeeze candidate.
The public markets are relatively new to Ecopetrol; until 2007, the firm was basically a branch of the government. The firm's size and strategic importance to Colombia make it an interesting play and soften out some of the risks in shares in my view.
Investors have bid shares of EC up to a short interest ratio of 18.3. At current volume levels, that means it would take more than a month for shorts to cover their positions.
Thermo Fisher Scientific
Lab equipment maker Thermo Fisher Scientific (TMO) is another name that short sellers hate right now. As I write, TMO sports a short interest ratio of 12.7, which means that it would take two and a half weeks for shorts to exit their bets against this stock.
Thermo Fisher supplies a massive catalog of scientific instruments, laboratory equipment, and consumables to more than 350,000 customers in the life-science, health care and environmental science industries. Because TMO develops and sells the products it offers, it sports a bigger economic moat than a mere supplier has. The firm's high-end mass spectrometry equipment, for example, leads the industry in sales, giving TMO a big extra advantage in selling the more commoditized consumables.
China and India present big opportunities for Thermo Fisher, particularly because both countries have large populations of professionals with science educations and low labor costs. Since TMO already has inroads into those markets, it's one of the best positioned names to benefit from their growth. A hefty cash generation record and rising analyst sentiment make Thermo Fisher a solid short squeeze play this summer.
Bangalore, India-based Infosys (INFY) is one of the country's legacy IT service providers, leveraging its cheap, educated labor force to court cost-crunched firms in North American and Europe. Despite an unsure global economy, demand for IT services has remained strong since 2009. INFY's cost argument has helped make it a go-to IT outsourcing option for Western management.
Since its start in the 1980s, application development and maintenance has made up the lion's share of Infosys' revenues. A skilled workforce of low-cost Indian programmers and consultants gives the firm pricing that competitors at home can't match, alongside expertise that's not easily recreated by other Indian firms. But more recently, the firm has graduated to providing services that ring the register higher up the value chain. By rounding out is offerings with consulting and the like, INFY is able to make the most of its existing customer Rolodex -- and take home bigger margins for add-on services.
Financially, INFY is in stellar shape, with around $4 billion in cash and zero debt. Continued strength in the dollar should provide a shot in the arm for INFY's earnings again this year. Despite the fortress balance sheet and earnings strength, this stock remains perennially high up on investors' hate list giving it a short interest ratio of 12.2.
It's been a pretty tepid year for shares of Salesforce.com (CRM). While the broad market has rallied double-digits this year, shares of the $24 billion customer relationship software company have essentially stayed flat. And it's not exactly hard to see why: CRM has struggled with profitability in recent quarters as it's invested heavily in new business. That's given short sellers the guts to ratchet CRM's short interest ratio up to 9.
In other words, it would take about a week of nonstop buying pressure in shares just for shorts to cover their bets.
Despite its shortcomings, Salesforce.com boasts a big, wide-moat business. The firm's marquee product enables its 100,000-plus customers to run business applications that interact with their customer lists, doing everything from sending newsletters to tracking sales. High integration with customers' internal systems means that switching costs are very high, which is a good thing. As one of the first big software vendors to base its business in "the cloud," CRM enjoys substantial recurring revenues, making it a cash generation engine that's only recently been obscured by big one-time items.
The announced $2.5 billion acquisition of online marketing firm ExactTarget will be costly too -- but it should slow down CRM's acquisition pace as the two companies combine. That should help to make Salesforce.com's business case a little more transparent in the third quarter.
Last, but far from least, is Chunghwa Telecom (CHT), a $25 billion phone utility that owns the dominant share of the Taiwanese mobile, Internet and fixed-line markets. Chunghwa currently pays out a 4.8% dividend yield, a payout that should help shake out short sellers. Dividends, after all, are like kryptonite to shorts.
Revenue growth at Chunghwa has been stair-step in the last few years, besting many analysts' expectations for the firm, and net income has slowly risen in kind. Even if that growth rate has slowed down in the last year, the cash that CHT throws off is substantial. In turn, that cash has helped to establish a balance sheet position in excess of $2.6 billion after debt is removed. That wherewithal is unheard of in a U.S. carrier -- and it gives CHT the wherewithal to continue to invest in its infrastructure without taking on leverage in 2013.
Shorts are still piled into this stock. Right now, CHT's short interest ratio comes to 15.6. That means that it would take more than three weeks of buying at current volume levels for shorts to cover their bets -- and it makes CHT a solid short squeeze possibility this summer.
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