Three Heavily Shorted Stocks for Explosive Returns

Andrés is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

No investment decision should be made solely based on an analysis of short interest. However, if a big crowd has taken a bearish position on a company, that may be a sign of opportunity for contrarian investors. Besides, if the bears are wrong, short covering can create spectacular gains as all the short sellers rush to buy the stock at the same time in order to cover their positions. Here are three heavily shorted stocks with the potential for explosive returns.

Betting the House

Housing is back, the recovery may be slow and it will have short term oscillations, but over the following years there will be a lot of money to be made in real estate and construction. Shares of homebuilder Lennar (NYSE: LEN) are reflecting this trend, as they have risen from less than $13 in October of last year to nearly $36.40 per share currently.

After such an exponential rise, many bears probably believe that the move is overdone, as Lennar carries 21% short interest, meaning that a 21% of the floating shares have been sold short and not covered. These short sellers may feel vindicated from time to time, particularly when macroeconomic concerns generate falling prices for companies in cyclical sectors, but they are taking a big risk by betting against a strong company which is well positioned for long term gains.

Lennar is ahead of the competition when it comes to restructuring its business, it has done better than peers like Hovnanian (NYSE: HOV) and Pulte (NYSE: PHM) in terms of recovering profitability after the crisis, and the company is also reporting higher profit margins in homebuilding activities, which means that Lennar will probably continue outperforming its competitors in the middle term.

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At a P/E near 14, Lennar doesn't look too expensive at all, especially considering that this well run homebuilder is in a privileged position to benefit from the real estate recovery over the next years. This house has solid foundations, so short sellers could be making a big mistake by betting against a strong company in the first stages of a long term recovery.

Buckle Up for this Dividend!

Fashion retail is a volatile business, especially when you are targeting teenagers and young consumers. This demographic group is particularly vulnerable to unemployment and other macroeconomic jitters, and they also have fickle spending habits. Perhaps for this reason, shares of The Buckle (NYSE: BKE) now carry a short interest ratio in the area of 25%.

But fundamentals at the company level are quite strong, the company is reporting year to date same store sales growth of 3.2% and the data for October was an even better increase of 3.8%.  Besides, the company has announced a $4.50 per share special cash dividend, as well as a $0.20 regular dividend, both of them to be paid to shareholders of record as of December 7.

When you are short a stock, dividends to the holder of the long position come out of your pocket, which means that short sellers will be liable for an almost 10% unless they cover their position before December 7.  A short squeeze in The Buckle over the next weeks is a clear possibility.

Open Table for Open Minded Investors

Open Table (NASDAQ: OPEN) is the leading online restaurant reservation platform, an industry which is proven to be beneficial to both restaurants and customers, and is showing promising perspectives for growth. The business is doing well, as the company recently reported a 17% increase in installed restaurants and a 26% increase in seated diners in its North American segment for the last quarter.

However, Open Table carries a whopping short interest ratio of 41%, which is probably explained by the proliferation of smaller competitors in different regions which are offering similar services for a materially lower cost. No company is immune to competition, and pressure is increasing for Open Table.

But the company has the first mover advantage, and it operates under the network effect; as more consumers use the service, the more valuable it becomes for restaurants to be on the network, which means a more comprehensive service for customers. More customers attract new restaurants, which makes the service more valuable and brings in even more customers.

Open Table operates in a dynamic and disruptive business and the risks are always high in these cases, particularly if a bigger player with more resources enters the scene. But the company is delivering strong results and rapidly building its network, so maybe it’s time to sit quietly and enjoy your meal while the company keeps growing and the bears keep shorting.

Bottom Line

The herd is not necessarily wrong on every occasion, but it does tend to exaggerate and over react in many cases. These heavily shorted stocks have attractive fundamentals, and they could deliver explosive returns if short sellers run for cover after realizing their making a mistake.

 


acardenal has no positions in the stocks mentioned above. The Motley Fool owns shares of The Buckle and has the following options:. Motley Fool newsletter services recommend The Buckle and OpenTable. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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