The short seller is the one trader most investors love to hate.
Often misunderstood and maligned, the short seller bets prices will
fall rather than rise. This doesn't earn the short seller much
popularity with most investors (who usually buy a stock hoping it
will rise), but it can be a very profitable strategy.
Here's how it works: A short seller thinks a stock's price will
fall, so he borrows shares from a broker. He then immediately sells
those shares and gets the cash from the sale. At this point, the
trader officially has a "short" position in the stock. If the
trader is right and the share price falls, he must decide when to
buy back the shares at the lower price and return them to the
broker. When he does that, the trader pockets the difference from
when he originally sold the shares.
If enough short sellers pile on against a stock that's declining,
prices can be significantly pushed downward. On the flip side, if
short sellers are wrong and a stock begins to rise, a beautiful
thing happens for all the "longs" (investors who buy a stock and
expect its price to rise) -- short sellers begin to "cover," or buy
back their shares. If the stock stages a significant rally, it can
create panic buying by shorts, causing what is known as a "short
Profiting from this "short squeeze" is the focus of today's "Inside
the Numbers" column.
Before we look for stocks that could benefit from a short squeeze,
it's important to understand a key metric -- the short interest
ratio . This is found by dividing the total number of shares being
shorted by the average daily volume of shares traded.
For example, if a company has two million shares short and an
average daily volume of one million shares, then the short interest
ratio is two (2 million / 1 million = 2), meaning it would take two
average days of trading for all the shorts to cover. Therefore, a
stock with a ratio of, say, eight, would mean that it would take
six more days for shorts to cover than a stock with a short
interest ratio of two. But it also means that if a short squeeze
does occur, the rally could be much stronger.
Still with me? Good. Now on to this week's screen…
I recently asked the StreetAuthority research team to look for
companies that could experience a short squeeze in the months
ahead. In order to qualify as candidates, they must not only have
an unusually high short interest ratio, but also be profitable with
good long-term growth prospects. Here are the criteria we used:
-- Short interest ratio greater than 7
-- Profitable earnings per share (
) on a trailing twelve-month basis
-- Long-term estimated growth of at least +8%
-- Operating margins of at least 15%
Here's what turned up:
Long Term Growth Est.
A few interesting things to note about our list:
- Two Buffett holdings,
Iron Mountain (
, make the cut. Clearly, Buffett sees something in Iron Mountain
that the shorts don't -- he hasn't made any major moves lately
and continues to hold about $180 million worth of the stock.
Buffett has been selling Moody's lately, and it seems traders are
following his lead.
- With a short interest ratio of 14, investors might be curious
Waste Management (
at the top of the list. Bill Gates is apparently a huge fan of
Waste Management (it's the Gates Foundation's second-largest
holding) and the trash business in general. So what gives? Turns
out, Waste Management is trading just -4% below its 52-week high
and its average daily trading volume of fewer than two million
shares is relatively low.
Paychex (Nasdaq: PAYX)
is another intriguing name on the list. The payroll service
provider's stock is closely tied to unemployment numbers and
interest rates. With unemployment likely to come down gradually
in the next couple years and interest rate hikes not a matter of
"if" but "when," it looks as if the shorts are playing a risky
game with this one. Wise investors should be scooping up shares
of this company. (More on Paychex here).
- It should come as no surprise that
First Solar (
is on the list. Shares have been known to be volatile, and the
company operates in a high-growth industry. But the shares aren't
just volatile -- they change hands like hot potatoes: 2.6 million
a day on average. This means all of First Solar's 85 million
shares outstanding could theoretically change hands in a little
more than a month.
The shorts have had their way lately: at a price of slightly more
than $110 a share, First Solar is trading -85% below its 52-week
high. First Solar has been beaten up so much lately, in fact,
that it's incredibly cheap. Shares currently change hands for
14.4 times earnings -- you would have had to pay an average
multiple of 52 during the past two years. First Solar is expected
to grow earnings at a +24% clip in the years ahead, yet investors
are only paying 17 times estimated earnings. Without a doubt,
First Solar looks to be the best short squeeze candidate of the
If you'd rather profit from a straight up short, you need to
check out this week's issue of Double-Digit Trading. In it, you'll
discover a healthcare stock set to plunge that could deliver a
quick +15% profit.
Disclosure: Brad Briggs does not own shares of any security
mentioned in this article.