For as long as I can remember, I have always questioned the status quo and the established way of looking at things.
If the majority is doing one thing, then it's my natural state to think the opposite. But as you likely know, a contrarian attitude isn't generally perceived in a positive way. But I was happy to find out I'm not alone in the investment world.
Many successful investors are contrarians by nature. In fact, being an investment contrarian can provide a huge edge. This is because the majority of investors is often wrong.
Once the crowd gets excited about a particular stock, investment or tactic, it's often a signal to do the opposite. The stock market has an uncanny knack for attracting the most possible money into an idea or stock right before a sharp change in direction causes many to take a loss.
And one way I take advantage of my contrarian nature is by locating stocks with heavy short interest.
Short interest is the total number of shares that have been sold short. Therefore, the higher the short interest, the more investors are bearish on the stock. High short interest is generally believed to be a bearish indicator. However, I have discovered that stocks with a high short interest tend to outperform their brethren during an uptrend. This is particularly true when short interest climbs along with the stock price.
I created a screen to locate stocks that fit this criterion and the result revealed two interesting picks…
1. SouFun Holdings (NYSE: SFUN)
This company is in the real estate technology sector and operates the largest real estate information website in China. Short interest has ramped up from just under 800,000 shares to nearly 3 million from March to December 2012. This increasing short interest comes despite a 17% increase in revenue to more than $127 million from $109 million last quarter year-over-year. The company provides an annual dividend yield of more than 7% and a nearly 32% profit margin.
Clearly, the rising short interest is a bet that China's real estate recovery will fail. The facts are that the country just posted its seventh straight month of rising home prices, so it appears the Chinese real estate slowdown is over.
That's why, as short interest has increased, so has the stock price. Shares have climbed from the $11 range in August 2012 to a recent $28. I like this stock as a momentum play with a $35 a share, 12-month target. But it's critical to keep in mind that Chinese companies don't have the best record of acceptable accounting practices, which can lead to potential fraud issues.
2. Research in Motion (Nasdaq: RIMM)
I am not a fan of BlackBerry, but this beleaguered technology stock has caught my eye. It has launched a comeback from the lows nearing $6 a share in September to a recent $12. Short interest has increased 36% to nearly 120 million shares at the same time as the stock is bouncing higher. It's critical to note this stock has fallen nearly 90% during the past five years due to continual weak financial reports, combined with heavy competition in the smartphone market
However, bullish investors are betting the launch of the BlackBerry 10 on Jan. 30 will turn the company around. This latest iteration of the popular BlackBerry smartphone boasts a revolutionary feature called the "Hub," which enables users to peak at all their messages and notifications without leaving the active screen.
In addition, the phone will launch with more than 70,000 available apps, which may create serious competition for Apple's (Nasdaq: AAPL) iPhone. Not to mention the fact that Research in Motion's Chief Marketing Officer Frank Boulben expects more than 200 carriers to offer the BlackBerry 10 by this summer.
There is heavy technical resistance at the $14 level and there's much riding on the success of the BlackBerry 10. The new product appears to offer revolutionary functionality, but I am not quite willing to take a long position just yet in the company. I would wait for a daily breakout close above $14 to enter longs. Should this occur, my 12-month upside target is $20 .
Risks to Consider: My short-interest screening method simply identifies stocks that have an increasing short interest while climbing higher. This provides candidates for investment consideration. SouFun Holdings has Chinese political and economic risk, not to mention potential accounting issues. Long positions in Research in Motion are bets on the new BlackBerry turning around the company's fortune. Although these two stocks have proven short sellers wrong, it does not mean their uptrends will continue. Always use stops and position size properly.
Action to Take --> I think the worst is over in China and things will continue to improve, so SouFun Holdings is a good pick right now as a long position. While Research in Motion appears to have an interesting new BlackBerry in the pipeline, I prefer to wait and see attitude on this stock. I willnot enter long before a breakout close above resistance and only then with small size.