The big U.S. stock market averages are back within spitting distance of all-time highs again in May, adding to the lengthening list of reasons why investors should be loving stocks in 2017.
But while investors should love stocks right now, it's the ones they hate the most that could pack the biggest gain potential this spring.
When sentiment gets to extremes against individual stocks, it creates an important buying opportunity. 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.
In other words, the largest massively shorted stocks are actually more likely to squeeze higher than to drop...
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 three big-name stocks that short sellers are piled into right now.
Dominion Resources Inc.
Leading things off is $48 billion utility stock Dominion Resources Inc. (D) . Dominion is an integrated power and gas utility with 25,700 megawatts of electricity generation capacity, 12,200 miles of natural gas pipelines, and 6,500 miles of electric transmission lines. The firm also operates one of the largest natural gas storage systems in the country, with nearly a billion cubic feet of storage capacity.
On the utility side of things, the firm serves more than 5 million energy customers in 14 states. Like most of its peers, Dominion has made a push toward increasing the mix of earnings that come from highly-visible, predictable regulated utility operations — 88% of Dominion's EBITDA last year came from the regulated utility business, versus less than half that a decade ago. That exposure to the regulated utility business is attractive — it gives the firm a predictable source of earnings over the long-term.
Currently, Dominion's short interest ratio is sitting at 10.01, implying that it would take more than two weeks of nonstop buying at current share price levels for short sellers to get out of this stock. Much of that shorting has to do with Wall Street's interest rate expectations from the Fed — under higher interest rates, Dominion's 3.9% dividend yield becomes less attractive.
But the utility story hasn't played out the way that most analysts have expected and that means Dominion could see a jump higher as soon as this week, when the firm announces earnings.
Intuitive Surgical Inc.
Short sellers are feeling the squeeze in shares of Intuitive Surgical (ISRG) . Since the start of 2017, Intuitive has been a serial outperformer, rallying more than 33%, and leaving the rest of the broad market in its dust. Still, that hasn't been enough to shake out the shorts just yet—and with a short interest ratio of 10.34, this stock remains a notable short squeeze candidate.
Intuitive Surgical makes robotic surgical systems for hospitals that want to be able to do less-invasive procedures than can be done by a surgeon's hands. It da Vinci Surgical System of robotic-assisted technologies, tools and services are deployed in more than 3,600 hospitals around the globe. ISRG also books recurring revenue by selling the surgical tools used by the devices. In total, some 70% of Intuitive's revenue in 2016 came from services and accessories, a pair of lucrative, recurring sales paths.
Intuitive's machines should continue to face strong demand from hospitals, especially as new surgical procedures get added to da Vinci's repertoire. Look for Q2 earnings in July as a potential squeeze catalyst.
Digital Realty Trust
Last on our list of potential short squeeze plays is Digital Realty Trust Inc. (DLR) , an $18 billion real estate investment trust that owns stakes in high-tech real estate. Like the Dominion Resources play, Digital Realty is largely a rate-driven short — but sellers are over-estimating the downward pressure marginally higher rates will provide high-yield stocks in 2017.
Digital Realty Trust owns more than 150 datacenters, internet gateways, and manufacturing facilities, comprising more than 22.8 million square feet of leasable space. That's an attractive niche, one that should have no shortage of high-value tenants in the years to come. Like other commercial REITs, DLR enters into long-term triple-net leases with tenants, giving it a stable, predictable stream of rental income that translates into a 3.3% yield right now.
DLR has been a perennially heavily-shorted stock in recent quarters (and a stellar performer lately partially as a result). The firm's short interest ratio of 20.48 means that it would take more than two months of buying pressure for shorts to get out of shares.