3 Uptrending Short-Squeeze Stocks

BALTIMORE (Stockpickr) -- Some of the best opportunities for market profits are found in contradictions.

The end of 2010 gave investors a broad-based rally for stocks, as indices such as the S&P 500 gained 24% in the last six months. In the process, scores of heavily shorted stocks have seen their share prices rocket as stronger fundamental numbers and overall bullish sentiment ruled.

But at the same time, many of these rallying stocks saw short-sellers increase their bets against them. That's a major market contradiction -- and it's one that could provide us with some potential short-squeeze plays in 2011.

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: 4 S&P 500 Stocks Poised to Rebound

To find these plays, I relegated my search to heavily shorted stocks that have made consistent gains over the course of the last 52 weeks. Naturally, 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 uptrending issues with short squeeze potential in 2011.

W.W. Grainger

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Shareholders of $9.23 billion facilities maintenance firm W.W. Grainger ( GWW) have had plenty to celebrate in the last year -- the stock has gained more than 38% over that time. But that hasn't stopped shorts from betting against shares. At present, Grainger's short interest ratio sits at 10.5, a number that suggests it would take more than two weeks for short sellers to close out their positions at current volume levels.

Grainger is the predominant supplier of maintenance equipment and safety products for business clients, taking a $6.2 billion share of the sector's annual sales. Unlike so many other large American firms, Grainger isn't looking abroad for growth. Instead, the firm is seeking to grow its top line by expanding its offerings (with rose by 30% last year) and slashing the efforts customers are undertaking to meet their needs.

While continued economic headwinds appear to be the principal reason for short interest in this firm, a strong financial profile should ensure that W.W. Grainger continues to hold its own.

That's the hope of the Columbia Acorn Fund (ACRNX), which rings in as one of Grainger's biggest institutional shareholders. Other fund holdings include Crown Castle ( CCI) and Donaldson Company ( DCI).

With an A+ buy rating, Grainger is one of TheStreet Ratings' top-rated distributor stocks. The stock has increased its dividend every year since 1971, earning it a spot on Fred Fuld's list of 22 stocks with 30-plus dividend increases.

Fastenal

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Fastenal ( FAST) has seen even stronger performance over the course of the last year -- nearly 50% gains, in fact. That bullish price action has come as a result of continued rising sales and profitability in 2010.

Regardless, Fastenal has the highest short interest ratio on our list of stocks, at 17.4. That suggests it would take the better part of a month for short sellers to close out their positions at current volume levels.

Fastenal is a major industrial supplier of fasteners and repair products, and as such the company competes with W.W. Grainger. But significant differences in distribution methodologies should mean that there's continued upside potential for both companies.

One of Fastenal's biggest institutional shareholders is Ruane Cunniff & Goldfarb, a New York investment firm that manages more than $14 billion in assets. Other holdings include Idexx Labs ( IDXX) and Google ( GOOG).

Ron Baron at Baron Funds also likes the stock, and with an A- buy rating, it's one of TheStreet Ratings' top-rated trading and distributor stocks.

AutoNation

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Another heavily shorted strong performer in 2010 was AutoNation ( AN), the $4 billion auto dealer that boasts 203 stores selling 33 different brands of new cars. Shares of the firm have rallied nearly 44% in the last year despite the fact that short sellers have pushed the stock's short interest ratio to 10.4.

It should come as little surprise that AutoNation has been the target of short-sellers -- after all, car dealers have seen sales get hammered in recent years as credit tightened and consumers suddenly become less apt to part with cash. But car sales have been on a major upswing of late, spurring buying of this stock.

Tight consumer pocket books can actually be a good thing for AutoNation, which makes significantly more money on used car sales than on new cars. As consumer demand for vehicles continues to rebound, shareholders of this stock should be big beneficiaries.

The Bill and Melinda Gates Foundation Trust is one of AutoNation's biggest shareholders. The foundation's other positions include McDonald's ( MCD) and Caterpillar ( CAT).

Other major holders of AutoNation include Private Capital Management , and the stock makes up 17.5% of Eddie Lampert's portfolio as of the most recent reporting period. It showed up on a recent list of stocks with large insider selling after insiders sold $8.4 million worth of stock.

To see this week's trades in action, check out the Uptrending Issues Short Squeezes 2011 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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