BALTIMORE (Stockpickr) -- For a stock market that's been hovering around all-time highs, there's certainly a lot of hate among investors right now. And that hate could be the most effective way to make money in 2014.
The fact of the matter is that hate is a powerful emotion to focus on in the markets. It's powerful 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 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.
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.
Up first is Monsanto (MON) , the $60 billion agribusiness giant. In a nutshell, Monsanto's products help farmers generate bigger crop yields from their farms. The firm's offerings 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 global populations grow, so too has Monsanto's business case. Crop yields need to continue to grow materially in the decades ahead to support more humans on the earth, and Monsanto's products are well-positioned to take advantage. Despite the benefits that MON brings to farmers' fields, the firm has historically had a fairly adversarial relationship with farmers. (MON has been heavy-handed with litigation aimed at farmers who use the firm's patent-protected seeds out of license, whether intentional or not.) Fixing that relationship while Monsanto is at its strongest could help the firm maintain high levels of profitability down the road as its traits fall off of patent protection.
Continued innovation is absolutely necessary for Monsanto to maintain its industry lead. The firm spends approximately 10% of its sales on research and development each year, a steep price, but one that's worth the cost. Interesting new partnerships with other large businesses should help MON generate new licensing revenues with limited execution risk.
Monsanto's short interest ratio currently sits at 10.13. That means that at current levels it would take more than two weeks of buying pressure for short sellers to exit their bets against this stock.
As of the most recently reported quarter, Monsanto shows up in Blue Ridge Capital's portfolio and on a list of Goldman Sachs' 50 Stocks That Matter Most to Hedge Funds.
2014 has been a stellar year for Exelon (EXC - Get Report) . Since the calendar flipped to January, this $28 billion energy generation and sales giant has seen its shares rally more than 20%. But that hasn't stopped short sellers from hating this stock. With a short interest ratio of 12.38, it would take close to three weeks of buying for shorts to cover. That makes EXC a prime short squeeze candidate this month.
Exelon owns a diverse array of energy assets. Its regulated utilities provide power and gas to some 6.6 million customers spread across the Central and Eastern U.S. It also owns an extensive nuclear portfolio, with 11 plants that combine for 34 gigawatts of generation capacity. The firm's $12 billion offer for Pepco Holdings (POM) would add considerably more territory to Exelon's regulated utility business.
Hefty exposure to nuclear power is a big plus for Exelon right now -- the firm generates approximately 20% of the U.S.' total nuclear generation. Nuclear plants provide extremely low-cost power, which means that EXC can earn industry-leading generation profits even if power prices fall considerably. As more places consider adding nuclear power to their generation capacity, EXC's expertise makes it an obvious choice.
A 3.74% dividend yield rounds out the financial picture in Exelon right now.
Car parts retailer AutoZone (AZO) has been riding some big secular tailwinds for the last few years. As I write, the average passenger vehicle on the road in the U.S. today is 11.4 years old, the oldest average fleet age since automotive data firm Polk began collecting stats. With older cars on the road, costs to keep those cars running are climbing too – and that's helping to drive sales at AutoZone.
AutoZone owns close to 4,700 stores across the U.S., and the firm has been expanding its reach into Latin America in recent years, with another 300 locations in Mexico and four Brazilian locations. It's not just do-it-yourselfers that frequent AutoZone's stores; the firm has more than 3,000 commercial counters inside its retail stores, providing parts for repair shops and service stations. That double-pronged approach means that AZO is able to book part sales for smaller DIY jobs alongside repair jobs that need to be done at a shop.
The decision to expand into Mexico provides some big growth opportunities at AZO, as does its much smaller position in Brazil. Both of those markets have large vehicle fleets that are older on average than those in the U.S., so as AZO's ex-U.S. business scales up, it should begin to materially contribute to the larger firm.
Right now, investors hate this stock. AZO's short interest ratio comes in at 12.16.
The most-hated name on our list today is M&T Bank (MTB) , the $16 billion regional banking stock that tips the scales as one of the 20 largest banks in the country (and is one of Warren Buffett's favorite stocks). With a short interest ratio of 27.22, it would take more than five weeks of buying pressure for short sellers to exit their bets at current volume levels. That means that just about any catalyst could trigger a short squeeze right now.
M&T Bank was one of the well-run regional names that actually fared well in the wake of the 2008 financial crisis. By actually sticking to retail and commercial banking and maintaining better underwriting standards, MTB ended up with a loan book that was high enough quality to make it through the lean years. Like other banking names, MTB sought to grow its business by acquiring smaller banking names -- and that's one of the big black clouds that investors are fixating on right now. Shares are seeing high short interest thanks to a regulatory edits to improve risk management and a pending acquisition of Hudson City Bancorp (HCBK) that's been a debacle.
All of that negative sentiment has been piling up for the last two years (meanwhile, net margins are consistently above 25% and shares have actually managed to rally more than 62% over that stretch). The sheet amount of event risk surrounding earnings and the Hudson City merger make the prospect of being short here pretty scary. As soon as shorts start covering, expect a chain reaction.
GPS maker Garmin (GRMN - Get Report) is another name that's been a perennially highly shorted name for the last year and change. Meanwhile, shares have rallied twice as hard at the S&P 500 over the last 18 months or so. Garmin's short interest ratio of 20.16 means that there's a full month of pent-up buying pressure in this stock at current volume level.
The reports of Garmin's death have been largely exaggerated. 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, it's generated meaningful growth in markets like fitness and aviation. 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.
Right now, Garmin carries almost $3 billion in cash and investments, with no debt. That hefty cash position covers approximately a third of the firm's market capitalization at current price levels -- that's a huge degree of risk reduction right now. Likewise, a 3.7% dividend yield is basically acting like kryptonite for short sellers, hacking away at returns while they hold shares short on margin. Look for next quarter's earnings as a potential squeeze catalyst.
To see these short squeezes in action, check out this week’s Short Squeezes portfolio on Stockpickr.
-- Written by Jonas Elmerraji in Baltimore.