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When too many shorts pile into a stock at the same time, it can become a painful lesson. A high level of short interest can become a built-in group of guaranteed buyers who sometimes suddenly, but sooner or later must buy to cover their short positions. When this happens at the same time, it can be like someone yelling fire in a crowded room, with everyone rushing for the exits in a panic. In this case, it can be shorts stepping over themselves to buy back the stock before another one does, and that can lead to a big surge in the stock.

Sometimes, it make sense to short stocks, especially when they are trading at overvalued levels, or when a company has a business model that appears to be terminal. However, when you can find solid business models and stocks that are undervalued, it can often pay to buy the stock before the majority of shorts potentially cover. Sometimes a short squeeze occurs when a company announces good news, and other times it can happen due to a general rise in the markets. Shorts have to borrow the shares they sold short and their brokers charge them for the borrowed shares. Sometimes shorts will throw in the towel and cover due to the expense and risk of being short, especially if the stock is no longer dropping. I have researched a number of companies and found a few that have solid business models and high levels of short interest. These stocks could see large gains in a short squeeze:

Vantage Drilling Company (NYSEMKT:VTG) operates 4 ultra-premium jackup rigs, three ultra-deepwater drillships, and two deepwater semi-submersibles. This stock was trading around $1 in early January, but it has been on the rise ever since and now trades for about $1.40. The stock still looks undervalued as it trades for just over half of the book value, which is $2.42 per share. Vantage shares are a good example of when shorts have made the mistake of staying in a trade for too long. In the past couple of months, the stock is up about 43% from the lows. Shorts could even see more losses as the stock still has upside, based on book value and other metrics. Investor interest for oil sector stocks is likely to continue rising with the price of oil. The latest data shows about 8.8 million Vantage shares are short and based on average daily volume of about 1.1 million shares, the shorts represent about eight days of trading volume.

Here are some key points for VTG:
Current share price: $1.43
The 52-week range is 97 cents to $2.25
Earnings estimates for 2011: a loss of 22 cents per share
Earnings estimates for 2012: a loss of 4 cents per share

Tutor Perini Corporation (NYSE:TPC) is a leading construction and engineering firm that specializes in hospitality and infrastructure projects across the U.S. This stock was in an uptrend as well, but recently dropped after earnings were lower than what some investors expected. Tutor Perini reported earnings of 50 cents per share for the fourth quarter of 2011, while some investors were expecting 75 cents. It looks like the shorts in this stock became active after the earnings miss and tried to push the stock lower but, the stock is already climbing back. Tutor Perini shares could have plenty of upside left as it trades for just about seven times earnings and below book value, which is $29.19 per share. The latest data shows about 1.2 million Tutor Perini shares are short and based on average daily volume of about 164,000 shares, the shorts represent about 7.2 days of trading volume.

Here are some key points for TPC:
Current share price: $14.44
The 52-week range is $10.08 to $26.87
Earnings estimates for 2012: $2.17 per share
Earnings estimates for 2013: $2.48 per share

United Continental Holdings Inc., (NYSE:UAL) is one of the world's largest airlines, however, it trades more like an energy stock because it often rises when oil drops, but lately it's been dropping as oil climbs higher. Since jet fuel is one of the largest expenses for airlines, rising oil can quickly cause concerns for investors in this sector. Oil has jumped about 10% in 2012, and this has taken United shares down from recent highs of about $25. However, United does have hedges in place that can mitigate the impact, and it also has a fuel surcharge ,which is used to pass fuel expenses on to passengers. Air travel has remained relatively strong and it appears that fuel costs are still at a level that is acceptable to most consumers. Another factor to consider is that high gas prices could even help airlines in some ways because if gas reaches $5 per gallon this Summer, it could be less expensive to fly when compared with driving. Earnings estimates for 2012, are right around $5 per share, which gives this stock a price-to-earnings ratio of just 4. The latest data shows about 38.4 million United Airlines shares are short and based on average daily volume of about 5.4 million shares, the shorts represent about seven days of trading volume.

Here are some key points for UAL:
Current share price: $19.96
The 52-week range is $15.51 to $26.84
Earnings estimates for 2012: $4.89 per share
Earnings estimates for 2013: $5.76 per share

Data sourced from Yahoo Finance. No guarantees or representations are made.


Disclosure: I am long TPC, UAL.

Disclaimer: Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for informational purposes only. You should always consult a financial advisor.

Source: 3 Undervalued Stocks With Short-Squeeze Potential