Just a couple of weeks ago, Weight Watchers (WTW) was down on its luck. Shares had slid more than 72% from January through the second week of October, and investors were guessing that the small-cap weight loss stock had even further to fall.
But that enormous pop wasn't just due to Oprah's star power. Weight Watchers also saw a major short squeeze. Shorts had piled into bets against Weight Watchers, shoving the firm's short interest ratio up above 20 for the second time in 2015 and positioning a full 57% of the stock's float short. That's a crowded trade -- and all it took was one positive catalyst to set off the squeeze, the buying frenzy that's triggered by short sellers who need to cover their losing bets to exit the trade.
The interesting thing is that short squeezes can happen in larger stocks too -- albeit usually with slightly less violent reactions. But when they do, they generate consistent profitability for investors who bet that the shorts were wrong. And the fact that the strategy can be replicated (without knowing Oprah's next big stock deal beforehand) is what makes it worth a closer look.
In fact, 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.
For our purposes, 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 payments giant Visa (V - Get Report) . Visa has been a solid performer in 2015, rallying nearly 20% from the start of this year to today. Compare that with the barely breakeven performance in the S&P, and Visa has managed to deliver some pretty standout gains.
But all along the way, short sellers have been betting against Visa en masse. With a short interest ratio of just over 11, short interest in Visa this year is the highest it's ever been since the firm's IPO in 2008.
Visa is the biggest name in electronic payments. The firm handles about half of all credit card transactions and three-quarters of all debit card transactions, a market share that creates a virtuous cycle for Visa's network. Consumers get Visa-branded cards because they're accepted everywhere, and merchants make sure they can accept Visa because everyone carries the card. As more of the world moves toward electronic payments over cash, Visa is well-positioned to keep growing at a fast pace.
One way Visa is grabbing onto growth is by acquiring Visa Europe, a business that's been separate for the better part of a decade. Visa isn't exactly getting a bargain here -- it's paying $23.4 billion for Visa Europe -- but the deal will make big strides at diversifying Visa's business away from the mature North American market. A weakening U.S. dollar in 2016 would make that deal even more attractive.
The short trade looks crowded in Visa right now, and that could spur a spike in buying pressure in this stock.
Calling M&T Bank (MTB - Get Report) a "regional bank" doesn't really tell the whole story. This $16 billion banking stock is one of the 20 largest banks in the country, with more than 650 branches and $97.1 billion in assets. It's growing fast too: M&T's asset base is up about 14% over last year.
But investors hate this stock. With a short interest ratio of 10.5, it would take more than two full weeks of buying pressure for shorts to cover their bets against M&T Bank. We can use all of that hate to our advantage in the final stretch of 2015.
M&T Bank has long been a well-run regional with some big black clouds hanging overhead. For example, the firm's planned purchase of Hudson City Bancorp dragged on for more than three years, as internal control and compliance concerns and regulatory hiccups delayed things. But that deal finally closed this week. Combined with the acquisition of Wilmington Trust in April, M&T's scale is going to be increased dramatically in 2016.
The closing of the Hudson City deal should pull some short interest off of M&T Bank in November. From a technical standpoint, this stock is starting to look attractive again. If shares can bounce off of the $120 level this week, then the path is cleared for a move up to retest this year's high-water mark.
Short sellers have been piling up in shares of industrial supply company W.W. Grainger (GWW - Get Report) . While short interest has backed off from the record highs set earlier this summer, Grainger still sports a short interest ratio of 10.3 as I write. At current volume levels it would take more than two weeks for shorts to get out of their bets against Grainger.
W.W. Grainger is one of the largest sellers of maintenance, repair and operating supplies to businesses. From paper towels to paint to safety equipment, Grainger sells it all to industrial customers. The firm's more than 700 branches make it the largest single industrial supplier in the U.S., a size benefit that gives the firm some big pricing and distribution advantages versus the competition. Because Grainger is one of just a couple of big fish in the industry, it's able to serve large national accounts that smaller regional suppliers can't service.
Innovation has been key to the industrial supply business. While brick and mortar stores built the company, more than a third of sales have moved to Grainger's e-commerce platform (up from just 20% a couple of years ago). Likewise, sales tools such as supply vending machines have helped Grainger keep a presence on customers' shop floors.
This stock's price trajectory hasn't exactly been constructive so far this year, but a positive catalyst (such as the firm's October sales release next month) could help trigger a short squeeze and change that. It makes sense to keep an eye on Grainger this fall.
Homebuilder Lennar (LEN - Get Report) has been a thorn in short sellers' sides in 2015. Since January, this $10 billion builder has outperformed the S&P 500 by double digits, eating away at shorts' performance numbers along the way. But apparently that hasn't demotivated shorts yet. Currently, Lennar's short interest ratio sits at 10.22, making it one of just 10 large-cap stocks with a double-digit short ratio right now.
Lennar is one of the largest integrated homebuilders in the U.S. -- and that's made it one of the biggest beneficiaries of the strength of the housing market in 2015. Lennar is involved in every step of the home sale process, from development and construction to title insurance and closing services. The firm also has exposure to multifamily properties.
A lot of Lennar's exposure comes from more entry-level homes across 18 states. That positioning lines up well with demographics in 2015. With millions of millennials in their late 20s and early 30s, demand from first-time homebuyers should be on the rise in the years to come. And with large amounts of land in Lennar's inventory, the firm has the capability to scale up its projects to cope with that demand.
Lennar's share price is hovering just shy of 52-week highs this fall. If short sellers suddenly need to exit this stock, it could spur a squeeze.
Last up on our list of hated stocks is Lululemon Athletica (LULU - Get Report) . Lululemon may be last, but it's far from least in terms of short selling. With a short interest ratio of 11.5, it would take two and a half weeks of buying pressure for short sellers to cover their positions at current volume levels.
Lululemon is a niche player in the hugely competitive athletic apparel business, best known for its line of yoga wear. Just 14 years after it sold its first yoga product, Lululemon has managed to carve out a moat as a lifestyle brand with a unique sales funnel. Approximately three-quarters of revenue comes from the firm's 302 company-owned stores and its Web site. That huge chunk of direct sales means fatter margins in an already lucrative space.
In recent years, Lululemon has invested heavily in expanding its store footprint. The firm has grown its store locations by more than 20% in the last year, and even more impressively, it's managed to expand without resorting to debt on its balance sheet.
While shares hardly trade for a bargain at current levels, the firm's fast growth makes it a strong short-squeeze candidate. Third-quarter earnings on Dec. 9 look like the next big potential catalyst for investors to look out for.