A stock with a high short interest ratio indicates that a large number of investors believe the price of the stock will fall in the future. In essence they are betting the stock price falls at which time they will buy back shares at a lower price resulting in a profit.
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The amount of short sellers can be measured with the short interest ratio. The number indicates the number of days it would take to cover all outstanding short positions at average volume. For example if there are two million shares short and the stock trades on average 500,000 shares per day, it would take four days to cover all shorts and the short interest ratio would be 4.0.
Stocks with high short interest ratios that are trading near highs or near a resistance level could often times be the recipient of a short covering rally. As a stock breaks through resistance, it results in the short sellers buying back shares and causing a major rally on heavy volume.
A few stocks that have strong charts and are at the top of my ratings list could be a group to watch as potential buy candidates.
SEE: Short Selling: Introduction
Bank of the Ozarks (Nasdaq:OZRK) is a Southeast regional bank that is based in Arkansas and that has approximately 113 offices in the area. The near $1.1 billion company has been solid through the financial crisis and the recent rally in the market. Shares are currently with a few percentage points of hitting a new all-time high. The short interest ratio is 18.8 and the stock pays a dividend of 1.5%.If the market rally continues the odds of a breakout to a new high and a short squeeze increases dramatically. The breakout level is $32.26.
Bankrate (NYSE:RATE) is a leading Internet company that publishes and distributes personal financial content via its handful of websites that include bankrate.com credit cards.com. The stock has been consolidating below an all-time high of $25.95 as the short interest ratio sits at around 16. As more people look to take control of their financial situation it could benefit RATE. There is also the housing angle that would be a major boost to the company's web traffic is home sales start to pickup again.
United Rentals (NYSE:URI) offers thousands of classes of equipment for rental to various industries. The equipment they rent ranges from generators to earthmoving machines. With a short interest ratio of 10.3 and trading at a decade high, the stock could be poised for higher prices as the short sellers give up and look to cover their positions. The stock is a play on the global economy and as long as Europe and China do not blow up, the trend appears to be on the side of URI.
SEE: When To Short A Stock
MAKO Surgical (Nasdaq:MAKO) is a medical device company that offers an advanced robotic arm and implants to the orthopedic industry. The company is not yet profitable, however the chart is impressive as it trades near an all-time high and the potential is very positive. The short interest ratio is 12.6 and a close above $45.15 would signal a new breakout and possibly a short squeeze.
The Bottom Line
I would never suggest buying a stock based on the short interest ratio alone. The combination of solid fundamentals, strong technicals and a good story behind the company are also integral in picking a winning investment. The four stocks above are the whole package and could be considered top-rated, with high short interest ratios that only add to their potential.
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At the time of writing, Matthew McCall did not own shares in any of the companies mentioned in this article.