BALTIMORE (Stockpickr) -- The last couple of years have been a major recovery story for financial stocks, which have taken more than a little heat in recent years for their involvement in the market crash of 2008. While financials were the worst place to put your money as the market collapsed, many have become a relatively safe investment now. How did that turnaround happen?
That their hands were forced had a lot to do with it. As risky financial instruments soured, investors cashed out, and defaults hit record highs -- and financial firms had to shore up their balance sheets quickly to placate investors and stay solvent.
Now, with reworked asset bases, these stocks are offering investors stronger businesses, many times at a discount to reasonable valuations. That hasn't stopped some investors from targeting financial stocks. Right now, some of the most interesting financial plays on the market have major bets against them, which could be creating an ideal short-squeeze opportunity right now.
A short squeeze is the buying frenzy that ensues when a heavily shorted stock starts to look attractive again to investors, causing short-sellers to cover their positions -- and 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 divides shares short by average daily trading volume in order to get a ballpark estimate of 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.
Here's a look at a handful of
that have the potential to see a short squeeze in the mid-term.
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It may sound surprising to know that one of the biggest targets for short-sellers right now is Canada's biggest bank,
Royal Bank of Canada
. The bank holds C$704 billion in assets and operates retail banking operations throughout North America. But that hasn't stopped short-sellers from pushing this firm's short interest ratio to 17.4 -- a number that suggests it would take more than three weeks at current volume levels for shorts to cover their positions.
Naturally, there are reasons behind shorting a bank such as RBC. The company operates with a relatively low common-equity-to-tangible-asset ratio, which means that the firm's solvency relies on maintaining its balance-sheet numbers. Likewise, the bank's U.S. operations focus on areas that were once incredibly profitable lending centers but are now plagued by defaults. All of that said, RBC's sheer size and deposit base add an incredible margin of safety to this stock -- especially considering the low cost of credit the bank itself is enjoying right now. Margins should expand in coming quarters if the firm can keep its defaults to a minimum.
One of RBC's biggest institutional investors is the
(GLFIX). The fund, which holds Morningstar's three-star rating, also owns stakes in
RBC isn't the only bank in our neighbor to the North that's on this week's list -- in fact, three of the five firms on this week's list hail from Canada. Another is
, Canada's second-largest bank by assets. The company currently has a short ratio of 18.5.
Like RBC, TD Bank benefits from a high percentage of performing assets, a strong retail banking environment and growth potential in the U.S. Also like RBC, the bank faces exposure to a less admirable geographic footprint in the U.S., as well as a relatively frail balance sheet.
But net margins have been growing of late - reaching nearly 24% in the second quarter of 2010. That's impressive profitability for any industry, particularly retail banking. Earnings on Sept. 3 could provide the catalyst short-sellers need for a squeeze.
has been successful in restructuring, the company has a tremendous black cloud for common shareholders as a result of shoring up its operations. That black cloud comes in the form of preferred shares that pay out double-digit dividends to investors who were willing to take on the risk of a liquidity-starved money transfer firm.
But shareholders shouldn't completely avoid shares of the company, which currently sports a short interest ratio of 13.2.
MoneyGram is one of the largest money transfer networks in the world, with more than 176,000 agents -- a list that includes the likes of retail behemoth
. Restructuring provided MoneyGram with the capital the firm needed to become profitable once again. Even if preferred shares cannibalize common shareholders' dividends in the short term, the cash infusion they provided is paying off in spades right now. Because those preferreds are convertible, the company has a way to convert its fixed-income obligations to more traditional forms of equity if the need arises.
Any indications of better returns for common shareholders could set off a short squeeze in 2010. Keep in mind, though, that this play is the riskiest of the financials on this week's list.
For the rest of this week's short-squeeze opportunities, including
Canadian Imperial Bank of Commerce
Capital Southwest Corporation
, check out the at
And to find short-squeeze plays of your own, be sure to check out the
community for insights and investment ideas.
-- Written by Jonas Elmerraji in Baltimore.
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At the time of publication, author had no positions in stocks mentioned.
Jonas Elmerraji 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.