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Johnson & Johnson is one of the top 10 stocks in the Trimark U.S. Companies Fund. (John Raoux/AP)
Johnson & Johnson is one of the top 10 stocks in the Trimark U.S. Companies Fund. (John Raoux/AP)

Market Outlook

Beat the market in 2013 with 5 of Wall Street's most-hated stocks Add to ...

Hate is a powerful emotion in the market. It's powerful because, more often than not, it's wrong.

Investors hate stocks that scare them. They hate stocks that have burned them. They basically hate any stocks that they don't already love. But what most investors don't realize is that taking a second look at Wall Street's most-hated stocks could provide some much-needed love for your portfolio in 2013.

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Going back over the last decade, buying heavily shorted large and mid-cap stocks (the top two quartiles of all shortable stocks by market capitalization) would have beaten the S&P 500 by 9.28 per cent each and every year. That's some material outperformance during a decade when decent returns were very hard to come by.

It's worth noting, though, that market cap matters a lot – short sellers tend to be right about smaller names, with micro-caps delivering negative returns when the same strategy was used.

Let’s replicate the most lucrative side of this strategy with a look at five big-name stocks that short sellers are piled into right now. These stocks could be prime candidates for a short squeeze in 2013.

In case you're not familiar with the term, a "short squeeze" is the buying frenzy that ensues when a heavily shorted stock starts to look attractive again to investors, causing share price to skyrocket. One of the best indicators of just how high a short-squeezed stock could go is the short interest ratio, which estimates the number of days it would take for short-sellers to cover their positions. The higher the short ratio, the higher the potential profits when the shorts get squeezed.

Naturally, these plays aren't without their blemishes – there's a reason (economic or otherwise) that these stocks are hated. But for investors looking for exposure to a speculative play with a beefier risk/reward tradeoff, these could be powerful upside plays for the coming year.

Without further ado, here's a look at our list of large-cap short squeeze opportunities.

Johnson & Johnson

It may seem surprising that blue chip giant Johnson & Johnson makes the list of most-hated stocks. The $200-billion healthcare firm is a go-to dividend name for income investors, and it's sitting on around $4-billion in net cash after all of its debt is accounted for. Even so, Johnson & Johnson currently sports a short interest ratio of 12, which means that there are so many short sellers piled into this stock that it would take more than two weeks for bears to exit this stock.

Johnson & Johnson is the biggest healthcare company in the world; it makes everything from consumer products like Band-Aid brand bandages to pharmaceuticals and medical devices. While patent loss concerns on JNJ's pharma unit contribute some to the negative sentiment in this stock, they don't account for the pile of short sellers that's currently positioned in shares. That's especially true now that the Synthes acquisition is closed, boosting JNJ's medical device business.

Financially, they don't get much better than JNJ. The firm's positive net cash position is attractive, and it's understated because of the mountain of cash that Johnson & Johnson parted with as part of the Synthes deal. In reality, JNJ's cash generation capabilities are impressive, and they should continue to fuel the firm's 3.43 per cent dividend yield for the foreseeable future. Late January earnings could be a big catalyst for a short squeeze.

Ecopetrol

Colombian oil and gas company Ecopetrol is another large-cap name that's getting hated by investors right now. The Bogota-based firm is at $120-billion is the biggest energy company in Colombia, generating around 70 per cent of the country's output. And with a 90 per cent stake held by the country's government, that market-leading position isn't likely to get ceded any time soon.

Ecopetrol is a vertically-integrated oil and gas firm, with operations ranging from exploration and production to refining and transportation. That integration helps keep EC's profitability numbers strong – and crude oil prices resting near historic highs for sustained periods don't hurt either. That said, exposure to the volatile Colombian Peso doesn't help investors' love affair with this stock, particularly given the strong performance of the U.S. dollar in recent years.

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