After nearly a decade of stock market gains, good deals in stocks with upside catalysts can be hard to find. Even some of the questionable investments seem to have been bid up in the search for higher returns.

Fortunately, there is one segment of the market that never disappoints in offering a buffet of potentially great investments.

#-ad_banner-#When everyone seems to love the market, I look at the stocks nobody likes.

Beyond finding stocks at bargain-basement prices, taking the contrarian side on a stock with heavy short interest offers the added benefit of protection when market sentiment turns sour. If nobody liked these stocks in the first place, plunging market sentiment isn’t going to affect them as much and share prices tend to hold up in a market rout.

That makes investing in heavily-shorted companies the perfect theme for a late-stage bull market.

Some People Just Hate For No Reason, Even In Stocks
Short selling has exploded over recent decades. Short sales now account for 32% of total trading volume, compared with only 9% in 1984.

There are several reasons investors might sell a stock short, some of which don’t even signal a negative outlook on the shares. Investors and insiders locked into the shares may be buying insurance against their positions until they can sell. Short-selling is also used heavily by portfolio managers to cover their positions without the need to sell profitable, long-term investments and incur taxes.

There is, however, the speculative side of short-selling — the investors hoping to profit from a drop in the share price.

While not all investors short a company for the same reason, the reaction to a higher share price is much more similar and dramatic. For insiders and portfolio managers, a losing short position eats away at the gain on their long position. Fear of missing out (FOMO) sets in and many will dial back on the hedge to participate on more upside in their long positions.

Speculators are even quicker to sell out of a short position, closing out bad trades to avoid further losses.

Anytime you look for contrarian investments, it’s important to keep an open mind and understand the short side as well. Look through analyst reports to understand why shorts are selling before you jump in on the other side. Often, the short-side has attacked a company for one specific downside that has already run its course.

That sets your investment up for massive gains when upside catalysts start coming through and the shorts are forced to buy, closing out their positions.

An added benefit to investing in heavily-shorted stocks when uncertainty increases in the broader market is that these names may suffer less when the market tumbles. Shorted companies trade much more closely to specific-company news and less on the overall level of investor sentiment in the market.

3 Great Contrarian Bets On Short Targets
There are a few fundamentals you want to look for when searching for contrarian bets on heavily-shorted companies. Most lists of short positions will focus on the number of shares shorted but this can be misleading.

Looking exclusively at the number of shares shorted or even the percentage of shares shorted relative to shares available in the market, the float, might not tell you what you need to know.

Companies with more shares issued will naturally have more shares shorted, even if a large part of the market isn’t betting against them. Companies with higher percentages of shares held by institutional owners and insiders might have a higher percentage of float shorted just as a hedge against those long positions rather than a bet against the stock.

You should also consider the days-to-cover ratio, which is the number of shares shorted divided by the average daily trading volume. It’s your best measure for a potential short squeeze in the stock. Combine that with a potential upside catalyst and you’ve got a stock primed to jump.

TherapeuticsMD (Nasdaq: TXMD) is a pharmaceutical company with an exclusive focus on products for women and advanced hormone therapies. Biotech stocks are often a target for short sellers because of the uncertainty around drug development and approvals.

The short position in TherapeuticsMD has grown to 37% of shares available and would take 27 days to cover, one of the longest days-to-cover ratios in the market.

The company has two late-stage drugs with FDA decisions expected in 2018. TX-004HR for moderate to severe dyspareunia, an addressable market of $20 billion in the U.S., is expected to receive a decision by late May. TX-001HR for moderate to severe hot flashes, an addressable market of $25 billion in the U.S., is expected to receive a decision by late October.

Mattel (Nasdaq: MAT) may only have 17% of its float shorted but there is an immense amount of uncertainty that surrounds the company right now. The bankruptcy of retailer Toys ‘R’ Us has led investors to question the distribution channel for major toy makers and added to inventory issues at Mattel in 2017.

Into the liquidation, Toys ‘R’ Us accounted for 11% of Mattel sales. That hurt revenue but the company still controls more than 10% of the U.S. toy market and a category leader in five of the seven largest toy categories. Mattel has strong partnerships within children’s entertainment to promote its toys and some tailwinds from 2018 launches including Jurassic World and Sunny Day.

With the level of uncertainty around the shares, a Days-to-Cover ratio of 11 can quickly become a short squeeze on any unexpected upside.

Gogo Inc (Nasdaq: GOGO) reported record quarterly results in February with revenue up 18% over last year’s fourth quarter. The company missed high expectations for earnings, sending shares tumbling towards a 52-week low. Short sellers have piled on selling 53% of shares available and pushing the cover ratio up to 16 days.

With more than 20 satellites and many more land-based antennas, the company provides global coverage for in-flight and airport connectivity. Its reach and technological advantage allow it to operate at the lowest cost to consumers versus competitors.

With in-flight connectivity still in its infancy, Gogo is primed to benefit from growth for years to come. The company reported a 46% annual increase in connected aircraft and a 36% increase in passenger uptake.

Risks To Consider: There may be a good reason some stocks are heavily shorted and shares can still suffer if the negative story plays out.

Action To Take: Position in heavily-shorted names with strong upside catalysts for return potential and protection from weakening investor sentiment in the overall market.

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