BALTIMORE ( Stockpickr) -- Want to beat the market in 2014? Focus on the big stocks that everybody hates.
After a 23% rally in the S&P 500 and new all-time highs over the last 12 months, you'd think that equities were enjoying a love-fest with investors right now. But au contraire. Instead, there's a long hate list on Wall Street.
Hate is a powerful emotion in the markets. It's powerful because, more often than not, it's wrong. Over the last decade, buying the most hated and 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.
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. Too much hate can spur a short squeeze, a buying frenzy that's triggered by short sellers who need to cover their losing bets. And with the rally weve been since late 2012, you can probably guess that there are lots of losing open short bets.
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.
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 the months ahead.