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.
Shares of datacenter operator Equinix (EQIX) are off to a strong start in 2014. The $9.5 billion firm is up 7.7% since the calendar flipped over to January, besting the S&P's 1.4% climb over that period. But that isn't changing the fact that EQIX is hated right now. With a short interest ratio of 10.3, it would take more than two weeks of buying pressure for shorts to exit their bets against this stock.
Equinix is the name behind 6.5 million square feet of datacenter space spread across the world. That's enough to make the firm the biggest provider of data colocation services, meaning firms pay EQIX to store their content on its servers and harness the speed of its network. As demand for cloud services continues to climb at the hands of increasingly connected consumers, there's a stiff tailwind at Equinix's back. That, in turn, has helped to drive stair-step revenue and profit growth in recent years.
Make no mistake: Equinix isn't cheap right now. In fact, the firm's share price comes with an earnings multiple of 120x. That's downright pricey. But it doesn't detract from EQIX's potential as a short-squeeze candidate; short squeezes are structural, so valuation matters a lot less in a crowded trade than most short sellers realize. If earnings in April come in better than expected this name could pop in spite of its price tag.
Digital Realty Trust
$7 billion commercial REIT Digital Realty Trust (DLR) is a whole lot like Equinix, but with a twist. Like EQIX, DLR has huge exposure to the datacenter business -- but it doesn't operate the servers itself. Instead, it owns the real estate: 112 properties with around 17 million square feet in all.
Don't think of DLR as another technology play. Instead, this REIT is more of a pure-play income generation tool. That's because DLR 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. The result is a predictable income stream and a huge 6% yield at current price levels.
Short sellers hate DLR right now. With a short interest ratio of 19.1, it would take almost a full month of buying pressure at current volume levels for shorts to exit their bets. From a practical standpoint, dividends are like kryptonite for short sellers they dramatically up the cost of holding a short position long-term. In turn, that ramps up the chances of a short squeeze in Digital Realty in 2014.
Wipro (WIT) is no stranger to being hated. This stock was on our list of squeeze candidates a full year ago. But betting against the herd has panned out well in Wipro: shares have rallied more than 46% in that period. With a short interest ratio sitting at a lofty 14.2, WIT's squeeze potential hasn't been played out.
And with shares up so much in the past year, it's a safe bet that shorts are starting to get fatigued.
Wipro is another tech sector name. The Bangalore, India-based IT outsourcer is one of the largest anywhere in the world. The firm got its start by offering large corporations cheaper outsourced IT expertise than they could find at home, but the real money today comes from higher-end consulting services where WIT is able to compete on more than just cost.
2014 is ushering in a new, more svelte Wipro. The firm split off its distracting side-businesses (like cooking oil and soap) last year, and it's now a pure-play IT services and products merchant. As long as demand remains hot in the IT space, Wipro's huge scale means that it should benefit more than most of its peers. A solid balance sheet with a deep net cash position don't hurt either.
Uniform rental giant Cintas (CTAS) is another name that's enjoyed some serious upside momentum in the last 12 months, in spite of heavy shorting. Since last March, Cintas has managed to ratchet almost 40% higher. Today, CTAS' short interest ratio comes in at a strong 12.2.
There's no question about it: Short-sellers hate Cintas.
Cintas is the leader in the uniform rental market, providing uniforms for employees at more than 900,000 businesses. From fast food restaurant and hotel employees to factory workers, more than five million people go to work each day wearing Cintas' uniform products. By renting and maintaining their uniforms, Cintas simplifies how its customers manage their images -- and CTAS gets the opportunity to add high-margin upsells along the way.
One of Cintas' biggest benefits is a big footprint that covers more than 8,000 local delivery routes. As the firm makes efforts to maximize returns from trucks going to existing customers, it should be able to keep boosting margins materially. Financially, Cintas is in good shape, with more than $400 million in cash and investments, and a reasonable level of leverage on its balance sheet.
Earnings on March 17 could be a squeeze catalyst. Stay tuned.
Sunoco Logistics Partners
Last up is Sunoco Logistics Partners (SXL), a $9 billion oil pipeline stock that lays claim to more than 7,000 miles of pipelines and 42 million barrels of storage capacity in its portfolio. Sunoco Logistics has been another momentum name lately; shares are up more than 10% in 2014 and 33% in the last year.
As a pipeline stock, SXL gets to participate in the sustained high energy prices of the last few years, without having to participate in the downside from direct commodity exposure. Instead, the firm earns fees for its transportation services. And because SXL is one of the rare independent pipeline names that moves crude oil, the recent rally in crude means that Sunoco Logistics' customers are becoming less and less price sensitive.
Sunoco Logistics' partnership model means that the firm pays out the vast majority of its income to shareholders in the form of a distribution (currently at 3.2%). That payout has been chipping away at short sellers' returns, a risky proposition given how crowded the short trade in SXL is right now.
With a short interest ratio of 10.5, it would take more than two weeks of nonstop buying at current volumes for shorts to cover their bets. So according to our model, this name has squeeze potential this month.
To see these short squeezes in action, check out this weeks Short Squeezes portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.