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At the beginning of 2004, few investors had ever heard of an online travel company called Travelzoo (Nasdaq: TZOO). This small Nasdaq-listed firm had a tiny market capitalization of around $150 million at that time and ran a simple website that advertised discounted last-minute travel deals. While the website was gaining in popularity, it hardly seemed a unique business model, as Travelzoo was competing in the same basic space as giants like Expedia, Travelocity, and Priceline.com. For the most part, the company's stock was locked up by a small coterie of insiders. Then, as now, insiders held more than 80% of the outstanding shares -- a little less than 3 million shares traded freely on the exchange out of a total base of close to 16 million. Apparently, a number of traders were convinced in early 2004 that Travelzoo's business model was a loser. These traders had been betting against the company using a technique known as short-selling, or simply shorting. Short-selling is basically the opposite of buying a stock -- you borrow and sell the stock first and then hope to buy it back at a later time at a lower price. For example, assume you want to short 100 shares of a stock trading at $10 that you feel will drop lower. To accomplish this, you would first borrow 100 shares of stock from your broker, and then immediately sell those shares on the open market for $1,000. Let's further assume the stock drops to $7.50 two weeks later. To close your short position, you'd now need to cover your short. That involves buying back 100 shares of the stock for $7.50, which would cost you $750. After that, you'd then use those 100 shares to satisfy your loan from your broker. Your profit on that trade would be the difference between your sale price of $1,000 and your cost basis of $750 -- that's $250. Bearish traders took on this very play in TZOO in early 2004, betting that Travelzoo was overvalued and locked into a competitive, low-margin business. Almost the entire 3 million share float was borrowed and sold short. The company's short interest ratio -- the total number of shares sold short divided by average daily volume -- stood at around 20. That means it would take about 20 days worth of average trading volume to cover all those shorts. At the time, the shares were trading well below the $10 mark. However, those short-sellers were soon to be in for a rude awakening. In late April of 2004, Travelzoo broke out to a new all-time high. And within two weeks, it was trading closer to $15 per share. Recall that when a stock rallies, short sellers lose money. Traders who had shorted Travelzoo at $10 were now down by 50% on their short positions. By this time, some shorts had already started covering their positions; these traders were looking to just cut their losses and move on. But there was a problem with that -- when you cover a short position, you must buy the stock. Buying the stock, of course, tends to push the shares still higher, causing even more pain for the remaining short sellers. That, in turn, can create a vicious cycle known as a short squeeze -- successive waves of short covering force a stock higher and prompt yet more waves of covering and accelerated buying. The result of the short squeeze in TZOO was impressive. As the chart below shows, the stock rallied from below $10 in early 2004 to a high of around $100 by December of that same year.  Thus,
within the span of 8 months, Travelzoo returned more than +1,000%. Thus, if
you had held onto your shorts over this time, you would have lost your
initial investment more than 10 times over. Of course, bad news for the shorts was great news for anyone long the stock at the time. If you'd jumped into TZOO as the company's short squeeze took hold, you rode one of the biggest winners of 2004. And the Travelzoo story is far from an isolated tale. Every year a handful of stocks get caught in short squeezes -- the gains from these events can be tremendous indeed. If you have the prescience to jump in ahead of the covering, then you can collect dramatic profits in a very short period of time. With these points in mind, my staff and I recently searched for companies that appear ripe for a short squeeze. Specifically, we looked for those with unusually high short interest, but solid profitability and above-average longer-term growth prospects. In the process, we looked for companies that met the following criteria:  Share
price greater than $10. Short
interest ratio greater than 7. Total
short interest greater than 25% of float.
Three-year annualized revenue growth of +15% or higher.
Operating profit margins greater than +15%.
Long-term estimated earnings growth greater than +15%.After running these criteria through StreetAuthority's advanced screening software, we came up with the following list of companies... Important Note: Throughout the remainder of this article, editor Paul Tracy and our research staff provide the names of 13 companies that meet the requirements above. However, in order to view the remainder of this article, you'll need to subscribe to our premium newsletter -- Market Advisor. After you subscribe you'll receive immediate access to this full article, as well as our monthly Market Advisor newsletter and a host of additional premium content. Please visit one of the following links to continue... Good investing!
Paul Tracy founded StreetAuthority and became Chief Investment Strategist in 2001. Prior to that he spent several years as Managing Editor at a multi-million dollar financial publishing firm with over 150,000 subscribers. In addition to his role as managing editor and lead financial writer, he was also responsible for equity research and managing a team of seasoned professional financial writers, researchers and market commentators. Paul's previous experience includes a position at Robert W. Baird & Co.'s full-service brokerage operations as well as economic research work on a Money and Banking project funded by the National Bureau of Economic Research. He has also spent time doing outside consulting and research for the University of Virginia, has appeared as a guest expert on several prominent financial radio shows, and has been a featured speaker at various investment conferences across the U.S. Paul graduated with a B.S.
in Finance and Management from the McIntire School of Commerce at the
University of Virginia.
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