BALTIMORE (Stockpickr) -- If you want to beat the S&P 500 by double digits in 2014, just focus on the stocks that investors hate the most.
That may sound unintuitive, but hate can be a powerful emotion in the markets. It's powerful because, more often than not, it's wrong. When investors get heated about a stock and a trade gets crowded, there's a often money to be made on the other side of it. (That's one of the tenants of contrarian investing.)
But don't just take my word for it. The data backs it up too.
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. So how do you cash in this month?
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 S&P 500 within grabbing distance of all-time highs, you can probably guess that there are lots of losing open short bets feeling the squeeze right now.
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.