Short-sellers are feeling the pressure this year.
As the broad market tests new all-time highs, it's translating into losses for the influx of short interest that has come into the stock market in the last few years. That's been a big driver for the 15% decrease in total U.S. market short interest since early 2016. Shorts are fleeing all but their highest-conviction bets, and they're adding to the broad market buying pressure in the process.
But not all of the short sellers have been squeezed out of big-name stocks just yet -- and that's providing a big opportunity to profit from the stocks they hate the most.
More often than not, when short-sellers are crowded into a big stock, they're wrong. That's not just my opinion, either: 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.
Too much hate can spur a short squeeze, a buying frenzy that's triggered by short-sellers who need to cover their losing bets to exit the trade.
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 four 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.
Digital Realty Trust
Up first on the list is real estate investment trust Digital Realty Trust (DLR) . It's not hard to imagine why short sellers are betting on a drop in shares of Digital Realty right now -- pressure toward higher interest rates generally translates into lower share values for real estate investment trusts. But that's not what's been happening. Instead, Digital Realty is up almost 40% over the last 12 months, leaving short sellers conspicuously down on DLR.
With a short interest ratio of 11.95, there's still plenty of short interest in this stock to trigger a squeeze. At current volume levels, it would take more than two weeks of nonstop buying pressure for short sellers to cover their bets.
Digital Realty is a specialty REIT that owns and manages technology-related properties, such as datacenters, internet gateways, and manufacturing facilities. The firm owns more than 140 properties comprising more than 26 million square feet of leasable space. The datacenter niche gives Digital Realty a valuable corner of the real estate market, helping the firm profit as demand for data storage and server rack space continues to move up and to the right.
Like most other commercial REITs, DLR enters into long-term triple-net leases with tenants, an arrangement that takes most of the variable costs off of DLR's shoulders and puts those costs on tenants instead. Tenants pay for insurance, maintenance, and property taxes, while paying Digital Realty predictable long-term lease fees. The result is a predictable 3.44% dividend yield at current price levels. With interest rates rising more slowly than DLR's property values in 2017, shorts are likely to find themselves flummoxed. Look for next month's fourth-quarter earnings call as a possible upside catalyst.
Car sales numbers have been coming in strong in the last few months, and while that's put investors' focus on the automakers, it's been an equally good thing for shares of CarMax (KMX) . In the last six months, CarMax's share price has rallied 25%, beating the S&P 500 by nearly a factor of four. That performance hasn't stopped short sellers from betting against this stock, though - as I write KMX's short interest ratio sits at 10.66.
CarMax is one of the biggest car dealers in the world, with a network of 158 superstore locations that sold more than 619,000 vehicles last year. The company is unique among car dealers in that it focuses on used cars - only about 1% of sales volume came from new cars last year. Considering the fact that the average profit on a used car is double the dealer profit on a new car, that's an attractive niche to own. The cars CarMax sells are late-model and low-mileage - while the firm will buy any car, vehicles that don't fit the firm's standards never hit a CarMax lot, and are instead sold at wholesale.
By offering used cars with a positive reputation, CarMax is able to collect a premium over local used car dealers whom consumers may be more suspicious of. The firm's size gives it some extra advantages over smaller sellers, including add-ons like financing and service contracts. More than 40% of CarMax sales result in financing through CarMax Auto Finance, adding another profit center to the equation that other dealers can't access. Buyers are clearly in control of the price action in this stock right now - that makes CarMax a prime short squeeze candidate in 2017.
The short case was simple: as smartphones and in-car navigation systems become universal, Garmin's (GRMN) portable consumer GPS units are going to fall by the wayside. Overall, that's been a pretty accurate forecast, but it totally misses the fact that Garmin has been finding success elsewhere, leveraging its GPS expertise in a bevy of consumer and niche products.
Garmin makes devices for the fitness, outdoor, aviation, and marine markets. Those corners of the electronics space come with bigger profits, and Garmin has found success spending R&D dollars in its most specialized segments and then trickling its technology down to its lower-margin offerings. Popular products like Garmin's Approach golf watch series and Vivo wearable fitness trackers are fueling growth on the consumer side, while outside the consumer space, Garmin takes dominant roles in the market for cutting-edge electronic flight decks in new aircraft, for instance.
While Garmin's product mix has changed significantly, its balance sheet remains impeccable. The firm currently carries more than $2.3 billion in cash and investments, with zero debt. That huge cash cushion pays for more than a quarter of Garmin's market capitalization today, and helps ensure stability in the firm's hefty 4.26% dividend yield. Dividends are like kryptonite for short sellers, so that, plus a 42% rally in the last 12 months, make Garmin a major candidate for a short squeeze in the quarter ahead.
The $9 billion medical device maker ResMed (RMD) is another big stock that's being targeted by short sellers despite a market-beating 23.3% rally in the last year. ResMed's biggest business is building devices to treat sleep apnea. The firm manufactures airflow generators and masks, catching a wave of growth as diagnoses of sleep breathing disorders continue to increase.
Demographics present an important tailwind for ResMed in the long term. As obesity rates and average population ages continue to rise in developed countries, so too have sleep apnea cases. While the firm does have competition in the sleep-disordered breathing space, a rising tide should continue to lift all ships in this growing market.
ResMed is another stock that's in stellar financial shape. While the firm currently has $1.2 billion in debt on its books, most of that is offset by a $782 million cash position. Meanwhile, shorts continue to hold onto this stock as it moves higher into 2017 -- a short interest ratio of 21.59 makes ResMed the most heavily-shorted stock on our list. It would take more than a month of nonstop buying pressure for shorts to cover their bets on ResMed and exit this trade, almost certainly propelling shares higher in the process.