Being a contrarian investor is not easy. You will be investing on the opposite side of the majority of investors. Many people will say you're wrong.
However, some of the market's greatest investors are contrarians. These include the likes of Jim Rogers , George Soros and Howard Marks, who all believe in going against the grain when it comes to investing.
So how do you find stocks that the broader market hates?
The easiest way is to look at which stocks have a high short interest. Investors might be short for any number of reasons, but if the company starts showing signs of strength, shorts will begin abandoning their positions.
That is because the potential loss for short sellers is unlimited -- there's no telling how high a stock can go. Once a stock starts ticking higher, a short squeeze can ensue when short sellers start covering their positions, which can in turn drive the stock even higher.
I've identified five stocks that have a relatively high short interest, but they also appear to be trading at valuations that might be attractive for deep value investors.
1. Conn's (Nasdaq: CONN )
Short interest: 32%
Shares of electronic and appliance retailer Conn's are down 45% this year and trade with a price/earnings-to-growth ( PEG ) ratio of 0.7.
Its cheap valuation has attracted notable hedge fund manager David Einhorn , whose Greenlight Capital hedge fund owns 3.3 million shares. Luxor Capital also bought nearly 3.5 million shares of Conn's during the first quarter. Each fund owns just under 10% of the company.
The stock fell off a cliff earlier this year when it missed on earnings expectations due to weakness in its credit services segment. However, Conn's credit services give it a unique competitive advantage -- because the Conn's shoppers who use its credit services often cannot get credit anywhere else.
After trading in the mid-single digits less than five years ago, CONN now trades at over a share. That is a tenfold return. Nevertheless, with the pullback, shares now trade at a forward price-to-earnings (P/E) ratio of 10.5, which makes it one of the cheapest retailers around.
2. JetBlue (Nasdaq: JBLU )
Short interest: 19%
While airline stocks have generally been terrible investments in recent years, the industry has been undergoing vast consolidation. This has helped streamline capacity, which should help improve pricing and margins for the remaining airlines.
Despite investors' negative sentiment over JetBlue, fliers remain happy. JetBlue continues to excel in customer satisfaction surveys -- but its premium service has yet to translate into premium revenue.
Nonetheless, the airline has a couple key opportunities for boosting revenues, including the rollout of its Fly-Fi fleet, which will offer in-flight Wi-Fi. JetBlue is also adding premium seating to long-haul flights, including New York to Los Angeles and San Francisco routes. Overall, JBLU is also another stock trading with a very low PEG ratio, coming in at 0.6.
3. Cabela's (NYSE: CAB )
Short interest: 22%
Shares of Cabela's are down 10% this year as the harsh winter hurt sales of hunting and fishing gear. This weakness continued throughout the first quarter, and the company has missed earnings in each of the past three quarters.
However, Cabela's is a leader in a niche market. As the economy rebounds, shoppers should have more money to spend on outdoors and hunting equipment, which is Cabela's specialty.
There is still value in Cabela's niche business model. Over the past decade, revenue has grown at an annualized rate of 10%, and shares are up close to 400% over the past five years -- yet with a PEG right at 1.0, CAB still offers compelling upside.
4. Vera Bradley (NYSE: VRA )
Short interest: 48%
At 48%, Vera Bradley has the highest short interest of these five stocks. In September, I noted that the short sellers' thesis on VRA was crumbling . VRA is up nearly 40% since then -- but short sellers are staying in the stock.
Shares are still 50% off their all-time high back in 2011. This comes as sales remained weak due to the tough economic conditions, which pressured consumer discretionary retailers. As employment picks up, so should spending on specialty fashion items -- and with no debt, Vera Bradley appears poised to continue investing in its turnaround, to short sellers' dismay.
5. Outerwall (Nasdaq: OUTR )
Short interest: 30%
One of the best plays on the demand for convenience, Outerwall operates kiosks for a number of goods, such as movies (RedBox), coins (Coinstar), gift cards and mobile phones. Even after a shake-up earlier this year by activist investor Jana Partners (which owns 8.5% of the company), the short interest in Outerwall is still relatively high at 30%.
Jana convinced Outerwall to implement a plan to return at least 75% of its free cash flow to shareholders. Outerwall is a cash machine, with free cash flow of more than a share.
Shares are up 7% since I profiled Outerwall in January . That's double the S&P 500 Index, but OUTR could be poised to continue outpacing the market. Outerwall trades at a forward P/E of 10 and an ultra-low PEG ratio of 0.6.
Risks to Consider: Obviously, these stocks have headwinds given the high amount of short interest. Investors should use caution as these companies still have execution risk that might hinder the company's ability to prove short sellers wrong. The market can also remain irrational for long periods.
Action to Take --> These stocks are trading at attractive valuations, and they all appear to be gaining strength when it comes to improving their operations. As investors realize the potential, the short covering rally could be set to take place over the next few months. Do your own due diligence to determine whether any of these five should have a place in your portfolio.
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