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Thursday, March 6, 2014 - 14:30
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Thursday, March 6, 2014 - 14:30

Why A Well-Known Investing 'Guru' Invested $75 Million In This 'Hated' Stock

Thursday, March 6, 2014 - 2:30pm

One of my favorite stocks for the next Internet boom has recently come under a short-attack. Investors are betting an impressive $4 billion that the stock price will tumble, while more than 11.8 million shares of this company are borrowed and sold short.

But this isn't one of your fly-by-night tech companies with no earnings. This $54 billion behemoth made almost $2.9 billion in earnings last year, and I think a bubble is forming that could send shares higher.

It's one of the most hated stocks on a shorted basis and I'm buying more.

Bubbles Can Form On The Short-Side As Well
High short interest in a company is usually reserved for small startups or financial train wrecks, companies that post little in the way of profits and trade at exaggerated price multiples. Risks are high in these stocks and investors on both the short- and long-side are looking at big moves if their theses plays out.

But short attacks can hit other companies as well and sometimes the selling can build on its own momentum. Increased short selling can drive the share price down, which seemingly validates the reason to be short. Others jump on the bandwagon because they figure that many investors cannot be wrong.

Understand that an investor creates a short position by borrowing and then selling the stock. To cover the position, they must later buy the stock. Even if there was an initial reason to be bearish on the stock, a bubble can form on the short-side as negative sentiment feeds on itself and the amount of borrowed shares grows. When the stock doesn't fall, or when positive news is released, all these borrowers can end up supporting the price or even driving it higher as they rush in to buy back the shares.

When a bubble forms on the short-side, I like to look for a strong outlook that will eventually send the shorts running for the exit, and few have a stronger outlook than a company I wrote about last November.

Are you ready for the next Internet boom?
In case you missed the previous article, we could be looking at another Internet boom within the next couple of years. This one will be based on an explosive increase in bandwidth and storage needs. Google (Nasdaq: GOOG) will be coming out with its Google Glass product this year and, for better or worse, will give people the ability to record and post Web videos of just about every waking second of their lives.

flickr/emccorp
EMC Corp. has led the market in worldwide external storage since 2008 and has even been gaining market share over the past four years.

Combine this with the increasing data needs from smartphone usage and you create a huge demand for information storage and infrastructure.

EMC Corp. (NYSE: EMC) has led the market in worldwide external storage since 2008 and has even been gaining market share over the past four years. Beyond storage, the company also owns 80% of VMware (NYSE: VMW), the leader in cloud virtualization, one of the fastest growing segments of information technology.

I posted my previous report covering EMC on Nov. 19, after the shares tumbled ahead of a disappointing third-quarter report that was largely expected. Shares are more than 12% higher since the article, but I am still a buyer and increased my position on Feb. 27.

Not only is the company's long-term outlook intact, but now I think a short-bubble has built in EMC and will either burst, sending shares zooming higher, or will at least support the share price until the demand for infrastructure and storage rebounds.

Short interest in the company has more than doubled in the past four months and it is now the second most shorted stock after AT&T (NYSE: T). Short-term investors have piled on as the company's core business slows but the long-term potential through cloud services and data management remain intact. Investors are betting almost $4 billion that the shares will fall, nearly 7.5% of the market capitalization. Short bets increased by 11.8 million shares as the stock fell 11% in the late-January market sell-off but have since recovered near 52-week highs.

What is amazing is that even as this massive short interest has been building since October, shares have not been under that much pressure. The stock slumped in late January with the rest of the market but is up more than 13% since October.

The company beat fourth-quarter estimates but provided guidance below expectations on slower growth in the core infrastructure segment. A restructuring plan was also announced, which spooked the market enough to send shares down almost 3% on the news.

Since weak guidance and the need for a restructuring plan only sent shares down 3%, it doesn't sound like the kind of weakness that will make all those short positions profitable, and I think many of the shorts will be forced to close out their positions when the idea fails to make them any money.

Not everyone hates the stock. Hedge fund guru David Einhorn just disclosed a $75 million stake in the company, established in the fourth quarter. More than 82% of the shares outstanding are owned by mutual funds and institutional investors, including Appaloosa Management and Citadel Advisors.

My target price remains at $34.85 on $2.05 per share in 2014 earnings, but I would bump my buy-under price to $28 on the strong upside potential from short positions clearing out. The high short interest doesn't necessarily add anything to the long-term outlook, but it does add some near-term support and could be a catalyst for a strong upside pop on any positive news.

Risks to Consider: Investor sentiment can trump strong earnings and outlook for an extended period and it looks like the market loves to hate EMC. Investors should be ready to stay invested even as pundits cry to get out. The upside catalysts are there, it's only a matter of time.

Action to Take --> EMC is in one of the best industries for future growth as more business services switch to the cloud and Internet traffic increases. Shares should perform well over the next couple of years while the high short interest adds a catalyst that could send prices up quickly.

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Joseph Hogue owns shares of EMC.
StreetAuthority LLC owns shares of T in one or more of its “real money” portfolios.