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In this article, I have identified two companies that have a significant short interest, have a tendency to meet or exceed analyst expectations, are priced at reasonable multiples, and present a compelling growth story that is not captured at the current valuation.

1. Zagg Inc (ZAGG)

ZAGG designs and sells protective coverings, audio accessories, and power solutions for a number of consumer electronics devices. Most notably, the company produces coverings for Apple's (AAPL) iPhone and iPad products. 27.80% of the float is shorted, and I believe that this short interest is excessive for a number of reasons:

  1. Growth Is Intact: ZAGG's growth story appears to be intact, with the company posting a staggering 154% year-over-year increase in operating income, an 80% year-over-year increase in diluted earnings per share, and a 59% increase in revenues over the same period. Smartphone and tablet sales should see strong growth for the foreseeable future, so I expect that the growth will be driven by secular tailwinds and company-specific strength.
  2. Valuation Mismatch: As noted above, the company is growing both profits and revenues at a high double-digit percentage clip, and gross margins are quite healthy, coming in at 46.1%. It seems that it's cheap at 11.14x past earnings, 1.08x sales, and with a PEG ratio of 0.43. Generally, when looking for short candidates, I look for "absurd" valuations, but I simply don't see that here.
  3. Full-Year Guidance Strong: At the most recent earnings call, ZAGG revised its full-year guidance to $256M and an adjusted EBITDA of $56M-$61M, implying 43% revenue growth and 23.6% - 34.7% EBITDA growth.

It's interesting to note that short interest has steadily decreased from mid February to the end of July. However, the short interest is still significant and I believe that being short this stock is dangerous, especially in light of modest valuation, a strong product lineup, and high-quality growth.

2. SodaStream International (SODA)

SodaStream develops a product that allows users to turn tap water into "soda water." Further, the company provides a number of flavorings that can be combined to create custom flavors. SodaStream's products are gaining traction at a number of retail stores, with availability at giants such as Wal-Mart (WMT), Best Buy (BBY), Target (TGT), and a host of others, it is puzzling that 47% of the float is sold short. For the following reasons, I believe this short interest is excessive:

  1. Surging Growth: In the most recent quarter, revenues surged 49.1% and earnings grew 43.9% over the year-ago period. Further, the company raised its 2012 revenue estimates to come in 40% higher than 2011's from previously guided 33%. In addition, the company expects a 55% increase in net income over 2011. The company also saw margins tick up slightly to 54% over the year-ago period of 53%.
  2. Reasonable Valuation: SodaStream trades at 23.06x earnings; fairly rich, but given the high growth rates, it's not a red flag. More interesting are the forward P/E of 13.48 and PEG ratio of 0.74, which seem fairly cheap for this level of growth. Certainly, in picking a short squeeze candidate, making sure that valuations aren't excessive due to hype; I believe that there is nothing resembling "excessive exuberance" with regard to this stock's valuation at current levels.
  3. Strong Balance Sheet: Finally, the balance sheet looks rock solid. With no long-term debt and $56M in cash, I don't believe that the company is anywhere near insolvent at this point nor do I expect it to be. It seems that short sellers expecting bankruptcy will be in for a fairly protracted wait, especially as net tangible assets appear to be improving significantly each year.

I can understand the superficial resemblance to Green Mountain Coffee Roasters (GMCR): we have a company that makes a novelty beverage product that has a fairly low barrier to entry. However, there are some key fundamental differences:

  • Green Mountain Coffee's valuation was sky-high, soaring well over 80x earnings and near 6x sales during its peak in 2011. SodaStream's is, as mentioned above, much more modest.
  • Green Mountain had to compete with Starbucks (SBUX), a lethal, larger competitor that had brand recognition strength, a more reasonable valuation, and paid a dividend. I do not see such a competitor to SodaStream at this time.
Source: 2 Heavily Shorted Stocks Due For A Squeeze