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Short (squeeze) stories
Investors can profit with tech stocks that have been unfairly shorted...but it's a risky strategy.
December 28, 2004: 3:27 PM EST
By Paul R. La Monica, CNN/Money senior writer

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NEW YORK (CNN/Money) - Travelzoo is up more than 50 percent in the past two months. IAC/InterActive and are both up nearly 33 percent. XM Satellite Radio has shot up 22 percent.

What do these winning tech stocks have in common? A lot of investors have been betting against them, as measured by high short interest.

It just goes to show that going against the professional bears can be profitable in the short-term.

You'd think that if a lot of people think a stock will go down, you should steer clear of it. However, since short sellers are selling stock that they have borrowed, they eventually have to buy it back. They hope to do so at a lower price -- but if the stock starts to rise, short sellers often rush to buy, pushing the price higher still.

Such "short squeezes" appear to be one reason behind the meteoric rises in many of these stocks.

Just look at IAC/InterActive (Research), Barry Diller's online conglomerate. According to the most recent short interest figures from the Nasdaq, nearly a quarter of the company's available shares were being held short as of Dec. 15.

But when IAC/InterActive announced last week that it was spinning off all its online travel businesses into a separate company, Wall Street cheered the news. That would have sent the stock up a bit.

In addition, a lot of shorts probably covered their positions to protect against bigger losses. Shares surged 6 percent on more than seven times their average daily volume.

Squeeze candidates

With this in mind, it might make sense for investors with a Fat Albert-sized stomach for risk to bet on some heavily shorted tech stocks. The key, however, is finding companies that are not only riding the proverbial momentum train but also have healthy fundamentals behind them.

Seven to be squeezed?
These heavily shorted techs have compelling valuations and healthy fundamentals.
CompanyShort Interest as % of floatP/EEst. EPS Growth
Sonic Solutions32%30.361%
Take-Two Interactive20.6%15.638%
* data as of 12/27/04 and based on 2005 estimates
Sources: Thomson/Baseline, Nasdaq, Reuters

Todd Campbell, president of E.B. Capital Markets, an independent research firm catering to institutional clients, said that the mistake that some short sellers make is shorting a stock merely because it has gone up a lot. If a stock has promising earnings prospects, then the run-up could continue for a while.

"It's far too difficult to short a strong stock. You may be right on a long-term fundamental basis but you can't underestimate the mania of the market in the short-term," said Campbell.

With that in mind, here a couple of tech stocks that could be short squeeze candidates.

Each has been heavily shorted but appears to have solid fundamentals and reasonable valuations.

Chinese Internet and mobile messaging company (Research); online travel firm (Research) and healthcare software developer Cerner (Research). In addition: chipmaker Cree (Research); digital audio and video software firm Sonic Solutions (Research); and Take-Two Interactive (Research), the company behind the wildly popular series of Grand Theft Auto video games.

Be careful out there

To repeat, this is a risky strategy. Take particular care with valuations that are exceedingly high.

For example, a basket of 26 tech stocks that had at least 20 percent of their available shares being held short as of mid-December are trading at an average of 55 times 2005 earnings estimates.

In addition, some stocks that have become the objects of short sellers' attention are expected to post earnings declines next year, such as disk drive maker Seagate Technology (Research), slot machine manufacturer Multimedia Games (Research) and online DVD rental service Netflix (Research).

And for every short squeeze, there are examples of companies where the shorts have gotten it right.

Tech Biz
Short selling
By Paul R. La Monica
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To that end, TiVo (Research) is down 6 percent in the past two months due to disappointing subscriber numbers in its latest quarter. (Research), an Internet search firm, has fallen about 15 percent while online jewelry retailer Blue Nile (Research) has lost more than 22 percent.

Wall Street was underwhelmed by guidance for each company's current quarter.

And cable operator Charter Communications (Research) has plunged nearly 25 percent in the past two months. The company has been the subject of some takeover rumors but it is awash in debt and reported a $3.3 billion quarterly loss in November.

So if you do your homework, you might be able to find companies that have been unfairly targeted by the shorts. But just remember that many stocks are often shorted for a good reason.

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