Underdog Smallcaps: Potential Short Squeezes

by: J Clinton Hill

Most bullies like to pick on smaller guys who often can do little to resist their sheer size and brute strength. The market is no exception and its bullies are the hedge funds and professional traders who typically "gang up" against smallcap stocks.

Yet, as in life, so it is in the market in that it is not the size of the dog in the fight but the size of the fight that is in the dog that counts most. Some of these hedge funds and professional traders may be long overdue for a bloody nose or black eye, and when they pick on the wrong smallcap, this is exactly what happens.

Such a scenario is better known as a short squeeze and Hillbent has screened for just such candidates under current market conditions.

  1. To bait these bearish bullies, there needs to be some meat left on the bone so we start with stocks trading at a minimum of $10 per share or higher.
  2. However, the trap is laid by requiring an outstanding float of 20mm shares or less along with a short interest ratio (estimated days to cover/close short positions based on average volume) of 10 or higher.
  3. Since bullies prefer to isolate their victims, the average daily volume is lowered to a minimum of 300k shares. (As a money manager, I typically never trade anything with average daily liquidity under 1.5mm shares.)

Now as mentioned, it’s the size of the fight in the dog that matters and some of these names listed below have plenty of fight in them.

To begin with, their projected earnings growth for next year places them in the top quartile out of 8,000 plus stocks while their previous 12 month’s return on equity has been positive (14% on average). Based upon the 20 companies that passed the screen, their average 3-5 years projected growth rate is 17.7%. These numbers are pretty good for any phase of the economic cycle, i.e. expanding, peak, contraction, or trough.

List of Results

Consumer Staples (American Greetings (NYSE:AM-OLD)); Retail-Wholesale (Netflix (NASDAQ:NFLX); Fred's (NASDAQ:FRED); Beacon Roofing (NASDAQ:BECN)); Medical (Sciele Pharma (SCRX); Psychiatric Solutions (OTCPK:PSYS); Cubist Pharmaceuticals (CBST)); Industrial Products (Encore Wire (NASDAQ:WIRE); China Security & Surveillance (NYSE:CSR); Calgon Carbon (NYSE:CCC)); Computer and Tech (SkillSoft (SKIL); Red Hat (NYSE:RHT); Premiere Global Services (NYSE:PGI); Microsemi Corp. (NASDAQ:MSCC); Infonet Services (NYSE:IN); Daktronics (NASDAQ:DAKT)); Oil & Energy (Allis Chalmers Energy (ALY)); and Utilities (Unisource Energy (NYSE:UNS); IdaCorp (NYSE:IDA); Avista (NYSE:AVA)). 

Summary Analysis

The average short interest ratio for the above 20 stocks is 12.63 days to cover and some of these names may have succumbed to just good old fashion industry rotation.

Yet, if the growth rates stated above are legitimate and sustainable, then this list offers compelling GARP (growth at a reasonable price) opportunities. The average p/e is 20.78; the average forward p/e is 15.25; and the estimated EPS growth rate over the next 12 months is 48.37%. At the very least, the names in this group demand further scrutiny and make an excellent starting point for further fundamental analysis. In due time, it could be the hedge funds and professional traders who shorted some of these companies doing the crying instead of their smallcap investors.

Disclosure: none