) -- When investors as a group feel strongly about something, it pays to take note. Often, that's because they're wrong.
That's especially true when they hate something. Hate is a powerful emotion, and it's a powerful disadvantage to bring into your investment decision-making. tTat's not just my opinion -- it's a fact. My research shows that buying the stocks everyone else hates could help you stomp the market.
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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.
So what do the numbers say?
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.
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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.
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.
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Naturally, these plays aren't without their blemishes -- there's a reason (economic or otherwise) that these stocks are hated. But for investors looking for exposure to a speculative play with a beefier risk/reward tradeoff, the data tells us that these could be powerful upside plays for the coming year.