3 Short-Squeeze Opportunities for 2011

BALTIMORE (Stockpickr) -- While the investment tone for 2011 has yet to be set (and likely wont be for some time), the New Year is going to provide a clean slate for a handful of companies that have been targeted by short-sellers this year.

And you can bet that phenomenon will translate into ample opportunities for investors looking to add a bit of extra risk to their portfolios and profit from a short squeeze.

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.

Related: Stocks With Big Insider Selling

To find these plays, I relegated my search to heavily shorted stocks that trade for a paltry premium to the assets on their books (or in some cases, a discount), which have also suffered a large price drop in 2010. From there, I limited it to the three plays with the highest potential for a rebound in the coming year.

To be sure, these three plays aren't without their blemishes -- there's a reason that these stocks are being heavily shorted. But for investors looking for exposure to a speculative play with a beefier risk/reward tradeoff, these could be powerful upside plays for the coming year.

With that, here's a look at three oversold stocks that have short squeeze potential in the new year.

Barnes & Noble

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Bookseller Barnes & Noble ( BKS) has had a rough time of it during the recession, and even now, taking a 25% haircut to its share price in 2010. That decline has, in turn, spurred short-sellers to take positions against the stock amid mounting financial challenges for the company.

Today, Barnes & Noble sports a short interest radio of 19.2, suggesting that it would take nearly a month for short-sellers to exit their positions at current volume levels.

Barnes & Noble is the biggest brick-and-mortar bookstore chain in the world, with physical locations, a growing college book business, an online sales presence and even a publishing arm. But that diversification hasn't spared the firm from languishing sales and growing debt from its latest acquisition spree. The online store could be the key to regaining some of the market share lost to digital rival Amazon.com ( AMZN) in recent years -- and so could the Nook, the company's popular e-reader, which is tied to its online store.

Speculation has been mounting this month that BKS's largest shareholder, Bill Ackman's Pershing Square Capital Management, was trying to facilitate a Barnes & Noble buyout by a competitor for $16 per share. While those rumors are only that at the moment, the surge in interest for Barnes & Noble could mean that a price recovery is sooner to come than anticipated.

In the meantime, income investors should continue to be drawn in by the company's hefty 7% yield, which is somewhat secured by the company's ample cash generation abilities.

Alere

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Health diagnostics firm Alere ( ALR) has done a good job of rebounding since the company's name change from Inverness Medical this summer. But while shares are up 37% since July, the stock is still dealing with double-digit losses on the whole year. Alere's short ratio currently stands at 11.1.

By integrating its medical diagnostic devices with health management programs, Alere is tapping an attractive niche as demand for medical products moves higher alongside the aging population in the U.S. While the company has been able to regain its profitability in the latest quarter and full year, that move has been tentative at best in 2010.

Investors will want to see management sustain stronger operations before they'll be willing to bid share prices up. That said, with an attractive product and reasonable financial health, this stock should have rebound power in 2011...That's the hope of major shareholders, like Seth Klarman's Baupost Group. In addition to Alere, Klarman and company also own major stakes in ViaSat ( VSAT) and News Corporation ( NWSA). Other holders of the stock include David Dreman and Private Capital Management.

Sears Holdings

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If retail stalwart Sears Holdings ( SHLD) seems to continually pop up on searches for attractive short squeeze opportunities -- perhaps it's because the company is just that. Shares of Sears are down just 10% on the year following a rally last month that sent shares 13% higher. Now, with a short ratio holding at 13.9, this company could finally be getting closer to a pop.

From the costly and questionable integration of Kmart to a broad-based pullback in retail spending, Sears has faced a number of major challenges in recent years. And while the company is still unable to deliver consistency to investors, the firm is moving in the right direction by finally leveraging its powerful portfolio of exclusive brands across its sales channels. With consumer sentiment pushing higher toward the end of 2010 (and bringing retail spending along with it), expect Sears to be one of the biggest beneficiaries of the return to "normalcy."

The Legg Mason Value Fund (LMVTX) is one of Sears' biggest mutual fund holders. The fund's other stakes include IBM ( IBM) and Aflac ( AFL). Bruce Berkowitz' Fairholme Capital also likes the stock, which makes up 9.4% of his total portfolio, as does Tiger Global Management, which initiated a new position in Sears in the most recent period.

To see this week's trades in action, check out the New Year's Short Squeezes portfolio on Stockpickr.

-- 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.

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