BALTIMORE (Stockpickr) -- There's a lot of hate bubbling up in the stock market this summer. We got our latest glimpse of that with yesterday's 0.97% drop in the S&P 500.
But that hate could actually be a good thing for your portfolio. All you have to do is load up on the individual names that other investors hate the most.
The fact of the matter is, hate is a powerful emotion to hone in on in the markets -- because more often than not, it's wrong. Don't take my word for it. The data bear it out as well. 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.
When I say that investors "hate" a stock, I'm talking about 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.
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.
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.
Investors hate agribusiness giant Monsanto (MON) right now. While shares are mostly flat year-to-date, short sellers have been piling into MON over the last few months, ramping its short interest ratio up to 11.18. That means, at current volume levels, it would take more than two weeks of nonstop buying pressure for shorts to cover their bets against Monsanto.
Monsanto's offerings are designed to increase farmers' crop yields. They range from genetically modified seed products to its Roundup line of herbicide (if the name sounds familiar, you can buy a consumer version of it at your local hardware store). Approximately 80% of all corn and 90% of all soybeans grown in the U.S. contain a Monsanto trait, making MON the league leader by a long shot. As food demands increase internationally, particularly in emerging markets, Monsanto's yield-driving offerings should attract farmers willing to spend more on their seed supply in exchange for drought resistance and Roundup immunity.
Historically, Monsanto has been heavy-handed with litigation aimed at farmers who use the firm's patent-protected seeds out of license (whether intentionally or not), and likewise, anti-GMO sentiment is very strong in 2014. That said, for a large number of applications, the point is moot. Yield trumps GMO in many cases (ethanol production, for instance). A low debt load and high levels of profitability (more than 20% net margins last quarter) should help shake the shorts out of MON in the coming quarter.
As of the most recently reported quarter, Monsanton was a holding in George Soros' portfolio.
Shares of virtualization software firm VMWare (VMW) are showing investors a strong year in 2014. Since the calendar flipped to January, this stock is up around 10%. That's nearly triple the S&P's return over the same stretch. But that outperformance hasn't stopped the short sellers from piling into VMW. Right now, shares tip the scales with a short interest ratio of 18.48, a level that indicates nearly a full month of buying would be needed for shorts to exit their bets.
That makes VMWare a prime short squeeze candidate this summer.
VMWare is the world's largest seller of virtualization software for servers. The firm’s tools are used to transform a single physical PC into multiple virtual machines, enabling data centers to offer more hosts without shelling out (or finding space) for new physical servers. With the demand for cloud services that we’ve seen in the last several years, that’s a good side of the trend to be on. VMW has also been building its desktop presence in recent years, courting corporate IT departments with remote access software.
The financials at VMW are solid. The firm currently carries $6.6 billion in cash, more than offsetting its $1.5 billion debt load. While VMWare's lofty price-to-earnings multiple at 44 is no doubt encouraging shorts, as is pressure from investors for majority owner EMC (EMC) to divest its stake, momentum is clearly on the side of buyers right now.
Industrial supply firm Fastenal (FAST) is a large-cap stock that seems to be high up on short sellers' hate list on a perennial basis. That continues to be the case today, with a short ratio of 10.16. Even though Fastenal may not present a hot momentum story, this firm is executing extremely well in the industrial supply industry right now.
Size matters at Fastenal. The firm sports more than 2,400 retail locations dotted all across the country, and a catalog that includes more than 410,000 types of fasteners and 585,000 different maintenance and repair products. It's that utterly massive inventory that makes FAST a one-stop shop for its customers. Innovations, such as industrial supply vending machines painted in FAST's signature blue and located at customer shops, are helping customers quantify costs while making it incredibly easy to drive FAST sales.
The incredibly fragmented nature of the industrial supply business means that there's still considerable business up for grabs in Fastenal's core market, especially given a return to economic growth. A balance sheet with zero debt and a 2.3% dividend yield round out the picture in this big supply stock: Things look strong in Fastenal right now.
Dividends are like kryptonite for short sellers. That little fact is helping to create a big short squeeze candidate in Realty Income (O), a $10 billion real estate investment trust. Right now, Realty Income's 18.27917-cent monthly dividend check adds up to a hefty 5.07% dividend yield. So why should short sellers fear the payout?
Realty Income owns more than 3,800 properties in 49 states and Puerto Rico, with a concentration on freestanding retail units. Contrary to popular belief, this big REIT isn't a pure play on the commercial real estate market; instead, REITs like this are a much more direct income generation bet. That's because the firm leases properties to tenants using long-term triple net leases, which give the firm consistent, predictable income growth without needing to worry about variables such as maintenance, property taxes or insurance -- tenants are responsible for those costs.
In recent years, Realty Income has expanded its focus beyond retail. The introduction of office, industrial and manufacturing properties have helped to diversify the portfolio. And it's important to note that adding those disparate use tenants doesn't really change the risk characteristics of Realty Income. With ample dry powder available in the form of a large credit facility, Realty Income is in good shape for 2014. Its whopping short interest ratio of 16.07 makes it a solid short squeeze candidate this summer.
Last up on our list of hated large-cap names is Garmin (GRMN), another stock that's been a perennial member of investors' "most hated list", and just incidentally, another name that pays out a large dividend. Garmin's 48-cent quarterly payout adds up to an annual yield of 3.52%.
Garmin is the leader in the GPS market. While the commoditization of car navigation devices has made investors nervous about Garmin's ability to make money (and driven short sellers to bet against this stock), that bear case hasn't played out. Instead, Garmin has grabbed high-margin sales dollars from the outdoor and fitness segments, where its innovative products (such as the Approach line of GPS-enabled golf watches) have been met with considerable popularity. Likewise, Garmin owns a lucrative niche in the high-dollar aviation market, where its $50,000-per-unit electronic flight decks have become standard equipment on every new light airplane manufactured today.
Since the firm can take the valuable R&D it generates on profitable segments and then trickle them down to commoditized businesses like car navigation, it continues to crush expectations. Likewise, moves toward OEM car navigation have the potential to inject margin back into that business for Garmin specifically -- it has the scale and premium brand to get an attractive deal with automakers.
Cash and investments add up to almost $3 billion on Garmin's balance sheet (the firm has no debt), enough to cover almost 30% of the firm's current market capitalization. That puts GRMN's ex-cash P/E ratio at a gaunt 11.8. In a market where investors are complaining about a lack of bargain opportunities, GRMN is just that.
Meanwhile, shorts have ramped up Garmin's short interest ratio to 11.5. Look for next quarter's earnings as a potential squeeze catalyst.
Garmin was also featured recently in "5 Dividend Stocks Ready to Pay You More."
-- Written by Jonas Elmerraji in Baltimore.
At the time of publication, author was long GRMN.