5 Hated Stocks to Buy to Beat the S&P in 2013

BALTIMORE ( Stockpickr) -- Don't let new highs in the Dow and the S&P 500 fool you; investors still don't like stocks right now. And they downright hate some of them.

As I write, investor confidence in stocks is still struggling. In spite of a 10% rally in the S&P 500 so far in 2013 (after a 13.4% climb in 2012), the fact is that most investors are still sitting on the sidelines right now -- and the ones that aren't are sitting on the edge of their seats waiting for any excuse to liquidate. I've said before that I think that's a bullish factor for stocks right now.

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But investors' apathy about the market isn't what's tradable in April; for that, we've got to turn to the names that investors hate.

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. But my research shows that that's historically been a pretty good gain indicator.

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.

Without further ado, here's a look at our list of large-cap short squeeze opportunities.

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Up first is health care IT firm Cerner ( CERN). Cerner's business centers around harnessing the tailwinds from the transition to digital medical records -- and the firm has been one of the industry's biggest names. Today, almost a third of U.S. hospitals use Cerner's Millennium platform to store everything from medical data to financial records. It's not just hospitals either; pharmacies and physician offices are using Cerner's platform to manage their records too.

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But none of that has stopped investors from hating this stock. At last count, Cerner's short interest ratio of 12.9 means that it would take short sellers two and a half weeks of buying activity to cover their positions at current volume levels. That's a lot of buying.

There are some big incentives working in Cerner's favor right now; the biggest is legislation. Government rules have mandated that medical facilities use electronic medical records for a while now, and because Cerner's platform fulfills the legal requirements of the program, it's enjoyed significant market share.

Another big incentive for medical facilities is getting paid. Cerner's offerings cut down the administrative steps needed to get practices and hospitals payments from either insurance companies or government programs. That helps lessen the blow of a costly medical IT package.

A push to attract smaller medical offices with a less pricey suite of tools should help round out Cerner's client list in 2013. In the meantime, the firm's $1.3 billion of net balance sheet cash should be plenty of wherewithal to handle any unexpected bumps in the road.


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It's understandable why investors hate Moody's ( MCO) -- the $12 billion ratings agency was at the center of 2008's financial crisis for failing to catch the subprime crisis when it over-rated mortgage-backed securities. But even that hate is looking overblown right now. As I write, Moody's sports a short interest ratio of 10.7, which indicates that it would take short sellers more than two weeks of buying at currently volume levels to exit their bets.

Despite 2008, Moody's (and its peers) remains a major player in the securities rating business. As one of the "big three" ratings firms, Moody's controls around 40% of the market for debt ratings, a position that gives the firm ample cross selling opportunities among its user base. With interest rates sitting near-zero right now, debt issuances are up as firms make the prudent choice of refinancing debt loads at higher rates. That gives Moody's a steady stream of business to keep up with now.

Moody's doesn't stop at debt ratings; like its peers, the firm also sells research and quantitative databases, products that (like ratings) are capital-light and produce impressive margins. Despite a big blemish from 2008, Moody's has retained its position as one of the few go-to ratings agencies in a market with high barriers to entry.

With the firm's recent efforts to shore up its balance sheet (it's now debt-neutral), Moody's made be due for an upgrade of its own. That makes this stock a prime contender for a short squeeze.


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Data center stock Equinix ( EQIX) may not operate the most sexy business out there, but what it does have is 6.5 million square feet of datacenter space spread across five continents. That huge position in datacenter capacity, a product that's highly in demand right now, has given Equinix stair-step revenue and earnings growth for the past several years. But it hasn't helped with how much investors hate this stock.

Equinix is the world's biggest provider of data colocation services. That means that data owners pay EQIX to store their content on its servers and harness the speed of its network. The firm's global footprint means that data has a shorter path to travel to its destination. That's a huge advantage for the growing wave of rich media, financial data, and other cloud services that's been popping up seemingly everywhere in recent years. As services continue to offer consumers more content on "the cloud," Equinix should continue to benefit from boosted sales.

Financially, Equinix is in solid shape with a $550 million cash and investment position that helps to offset its modest $3 billion in debt. Still, investors have piled in a big position against this $10 billion data stock. At last count, EQIX sported a short interest ratio of 15.82. That's more than three weeks of buying pressure just for shorts to exit their positions.

Chipotle Mexican Grill

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Chipotle Mexican Grill ( CMG) is enjoying a nice rebound in 2013. Shares of the popular fast-casual restaurant chain have rallied close to 12% this year after correcting hard last fall. In 2008, Chipotle was an anomaly, throwing off huge same-store growth rates at the exact same time that most other restaurant chains were struggling just to keep declines in the single-digits. But Chipotle's combination of bargain positioning and an emphasis on marketing its stance on quality ingredients proved to be the winning combination for consumers. By and large, it still is.

Today, Chipotle boasts more than 1,200 restaurant locations spread across 42 states and four countries. Food costs remain an ongoing challenge for volume-movers like Chipotle because while values for many assets deflate, food commodity costs have been rising for the last several years. That said, Chipotle's skew towards higher-end, less commoditized ingredients should help diffuse its exposure relative to peers.

One of the most impressive parts of CMG's growth story is how it's been financed. To date, Chipotle has almost exclusively used cash from operations to finance its growth so far, maintaining an immaterial amount of debt on its balance sheet that's more than offset by a $662 million cash and investment position. While shares are far from cheap right now, they don't justify the short interest ratio of 11.8 that's currently weighing them down.

Digital Realty Trust

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All of the business tailwinds that make Equinix look attractive right now bode well for another big heavily-shorted name on our list: Digital Realty Trust ( DLR). DLR is a real estate investment trust that owns around 100: mainly datacenters, internet gateways, and manufacturing facilities. In all, the firm owns more than 16.8 million square feet of leasable space.

While DLR is a less direct play on the cloud computing boom, high demand for datacenter capacity should continue to keep tenants bidding up rents for Digital Realty's specialized properties. And because DLR is a REIT, it benefits from some huge advantages that more direct plays don't have. The firm enters into long-term triple-net leases with tenants, an arrangement that takes most of the risks off of DLR's balance sheet and puts the onus on tenants instead. Because there's a meaningful amount of customization required for datacenter spaces, tenants also have big sunk costs and higher stickiness than most other commercial real estate renters do.

Finally, there's the dividend. Because DLR's REIT status means that the firm must pay out the vast majority of its income to investors as dividends, it sports a huge 4.4% yield. That bodes well for longs given the firm's equally hefty short interest ratio of 13.4 - dividends, after all, are like kryptonite for short sellers.

To see these short squeezes in action, check out this week'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, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.