3 Nasdaq Stocks Headed for a Short Squeeze

Investors can find treasure among Nasdaq stocks in some unlikely places.

Like heavily "shorted" stocks, for example.

Short sellers borrow stock and sell it at the current price. At some point they must replace the shares they borrowed, which ideally means shares bought at a lower price.

But short sellers can be wrong. If the stock they shorted rises, they lose money. The more a stock rises, the more their replacement shares cost. And the more money the shorts lose.

If the stock rises rapidly, it creates a "short squeeze," forcing short sellers to buy shares quickly before the price goes even higher and they lose even more money.

Nasdaq stocksBut while a squeeze is the short seller's worst nightmare, it can be a tremendous profit opportunity for everybody else.

That's because a short squeeze drives a stock's price up faster than it would normally go.

The trick is to identify stocks with a lot of short interest that really don't deserve it. In those cases, the odds of a short squeeze are pretty good.

Short interest is simply the percentage of shares available to investors (the "float") that have been sold short. So, if a stock has a float of 100 million shares and 10 million are sold short, the short interest is 10%.

Most stocks have some short interest at any given time - that's normal. But when short interest gets into the 10% to 20% range, it means a significant number of investors see problems with the stock.

And the higher the short interest, the bigger the squeeze if they're wrong. The most shorted stocks can have interest of 40%, 50% or higher.

Another factor that can makes short squeeze worse is the "days to cover." This is the number of days, given the number of shares shorted and the average daily trading volume, it would take to close out all the short positions.

The higher the days to cover, the harder it is for short sellers to exit their positions as a stock's price rises. The lack of liquidity can further fuel a short squeeze situation.

Right now 107 Nasdaq stocks out of approximately 3,100 total have short interest of 20% or more.

And we've found three excellent short squeeze prospects near the top of that list...

3 Nasdaq Stocks the Shorts Have Wrong

Surprisingly, the three stocks we like the best are among the top seven most-shorted Nasdaq stocks according to Wall Street Journal data. That means the shorts are really down on these stocks. But it also means any short squeeze will be that much more dramatic - and profitable for investors who are long.

Short Squeeze Nasdaq Stocks No. 1: Pilgrim's Pride Corp.

  • Why the shorts are betting against it: As of March 31, Pilgrim's Pride Corp. (Nasdaq: PPC) was the most-shorted Nasdaq stock, with short interest 63.6% of the float. With 15 days to cover, PPC could get quite a kick out of a short squeeze. The Greely, Col.-based company is the second-largest chicken producer in the United States. One thing the shorts don't like is the lack of diversity. Chicken is pretty much all Pilgrim's Pride does. Adding to that is concern that rising chicken supply will put pressure on profit margins. But the shorts seem to be betting on the news over the past year that widespread use of antibiotics in the raising of chickens could pose a health hazard. An outbreak of avian flu last month put another blemish on the industry. Finally, 75% of PPC shares are owned by Brazilian meat-processing giant JBS S.A. (OTCMKTS: JBSAY), reducing liquidity.
  • Why the shorts are wrong: The case for shorting Pilgrim's Pride is weak. Although PPC stock has dropped 25.28% in 2015, it's up 159% over the past two years. The fact is, the chicken business is booming. The USDA estimates that U.S. chicken consumption, already up because it is generally cheaper than beef or pork, will keep rising faster than other meats at least through 2025. Chicken exports are also expected to rise. Concerns about antibiotics appear overblown, as the industry has already taken steps to reduce their use. As for diversification, Pilgrim's Pride is actively looking at an acquisition this year that would add beef, pork, or other foods to their arsenal. Plus, PPC's financials are excellent. The company has only $4.24 million of debt against $576.1 million in cash. And free cash flow increased to $895 million last year.

Short Squeeze Nasdaq Stocks No. 2: Insys Therapeutics

  • Why the shorts are betting against it: The short interest on Insys Therapeutics Inc. (Nasdaq: INSY) is 59.7%, with the days to cover 15. Based in Phoenix, Ariz., Insys is a specialty pharmaceutical company best known for its Subsys fentanyl spray. The shorts locked onto INSY stock after a controversy over certain doctors who were allegedly involved in Medicare fraud as well as overprescribing Subsys. Any negativity surrounding Subsys is bad, as it contributes nearly all of the company's revenue. In September of last year the U.S. Attorney in Massachusetts started investigating Subsys marketing practices. Health and Human Services is also investigating Insys for possible violations of HHS programs. A year ago Mylan Pharmaceuticals Inc. sued Insys claiming that it had wrongly tried to end a distribution deal. Shorts also may be hoping INSY is overheated. The stock is up 43% in 2015 and 72% over the past 12 months.
  • Why the shorts are wrong: The legal problems look bad, but nothing has come of them so far. Insys has cooperated with authorities in all cases. In particular, the company has said it had no connection to the Medicare fraud. And analysts have not lowered expectations based on any of these events, an indication they believe they won't amount to anything. Meanwhile, business is going very well for Insys. It reported earnings last month of $66.5 million, up 65% year over year, driven by Subsys sales. These profits have allowed Insys to finance a hefty pipeline, including plans to initiate five Phase III clinical trials. At least one has the potential to be a blockbuster drug. This is a biotech that could explode.

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Short Squeeze Nasdaq Stocks No. 3: VASCO Security Data

  • Why the shorts are betting against it: The short interest on VASCO Data Security International Inc. (Nasdaq: VDSI) is 45.3%, with eight days to cover. Oakbrook Terrace, Ill.-based VASCO provides cybersecurity solutions, particularly products that use "two-factor authentication." It has more than 10,000 enterprise customers, including more than half of the top 100 banks in the world among its customers. Why it's so heavily shorted isn't terribly clear. VDSI stock fell 6% in February after beating on its Q4 earnings. Maybe the shorts were concerned by guidance that 2015 was front-loaded, as a major contract with Rabobank will be filled as of mid-year. But the company also pointed out that its backlog was higher than at the same time in 2014. Or maybe they don't like the short-term nature of VASCO's contracts. Or that 92% of the company's revenue comes from outside the United States. But is that enough to make it the seventh-most shorted Nasdaq stock?
  • Why the shorts are wrong: The heavy shorting of VASCO is a true head-scratcher. Cybersecurity is a fast-growing sector, and VASCO is a market leader. In the Q4 results that so troubled the shorts, VASCO reported a 44% increase in revenue and tripled its earnings per share. The company has reported 47 consecutive quarters of profitability. VDSI stock is up 226% over the past 12 months (maybe the shorts think it's due for a pullback). But looking ahead, VASCO is expected to increase earnings 28.7% in 2015. It just launched a new cybersecurity technology called CrontoSign and has more products in the pipeline. Even without the prospect of a short squeeze, VDSI stock is a great buy.

Now, Three Stocks to Short: Shorting stocks is a solid investment strategy if you make the right choices. And there's actually a tool investors can use to identify the best stocks to short. Here's how to find stocks to short - and three picks to get you started...

Follow me on Twitter @DavidGZeiler.

About the Author

David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.

Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.

Dave has a BA in English and Mass Communications from Loyola University Maryland.

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