Beat the S&P With 5 Stocks Everyone Else Hates

BALTIMORE (Stockpickr) -- There's a lot of hate bubbling over on Wall Street right now. According to Bloomberg data, U.S. total short interest is at the highest level it's been since the March 2009 market bottom. That means that, this summer, bets on a tumbling market are ramping up at a pace not seen since a major market extreme.

>>5 Breakout Stocks for a Market Near All-Time Highs

And could be a very good thing for longs right now.

The fact of the matter is, hate is a powerful emotion to hone in on in the markets because, more often than not, it's wrong. Don't take my word for it; the data bear it out as well.

Over the last decade, buying the most hated and heavily shorted large- and mid-cap stocks (the top two quartiles of all shortable stocks by market capitalization) would have beaten the S&P 500 by 9.28% each and every year.

When I say that investors "hate" a stock, I'm talking about its short interest. A stock with a high level of shorting indicates that there are a lot of people willing to bet on a decline in its share price – and not many willing to buy. Too much hate can spur a short squeeze, a buying frenzy that's triggered by short sellers who need to cover their losing bets.

>>5 Rocket Stocks to Buy for Summer Gains

One of the best indicators of just how high a short-squeezed stock could go is the short interest ratio, which estimates the number of days it would take for short-sellers to cover their positions. The higher the short ratio, the higher the potential profits when the shorts get squeezed.

Today, we'll replicate the most lucrative side of this strategy with a look at five big-name stocks that short sellers are piled into right now. These stocks could be prime candidates for a short squeeze in the months ahead.

AT&T

Telecom giant AT&T (T) tops off our hate list this week. With a short interest ratio of 10.18, it would take short sellers more than two weeks of buying pressure at current levels to cover their bets. More important, AT&T's short interest ratio is the highest it's been since September 2006. Much of that shorting comes from the pending DirecTV (DTV) deal, but that doesn't change the fact that shorts could get squeezed in 2014.

>>3 Tech Stocks Spiking on Big Volume

AT&T is the No. 2 wireless carrier in the U.S., with approximately 99 million cellular customers. Wireless may be AT&T's most profitable business, but its legacy wireline assets contribute a huge share of operations: The firm operates 28 million phone lines and has 17 million internet users. As AT&T packages more of those customers on higher-margin "triple-play" packages, AT&T should be able to find meaningful growth potential in the years ahead with lowered customer acquisition costs. Exposure to Europe (and soon Latin America through DTV) is another growth avenue for AT&T -- but one of the biggest valuation bumps comes from just how much top rival Verizon (VZ) paid to buy 45% of its wireless arm from business partner Vodafone (VOD) last year.

From a financial standpoint, AT&T is in solid shape. Shares currently trade for a P/E ratio of 10, and even though the telecom business is capital-intense, AT&T has a long track record of paying of a hefty dividend yield. Currently, that payout sits at 5% -- and dividends are like kryptonite for short sellers.

Waste Management

$20 billion trash stock Waste Management (WM) is another large-cap name that's high up on investors' hate lists this week. WM tips the scales as the largest waste services firm in the country, with approximately 270 landfills and nearly 300 transfer stations in its network. The firm also owns 22 waste-to-energy plants that are designed to turn the waste that WM literally gets paid to collect into renewable energy that the firm gets paid for again.

>>5 Stocks Set to Soar on Bullish Earnings

So calling WM the biggest "trash stock" is a compliment, not a jab.

Waste Management's garbage business has a reputation for being "recession-proof" -- and while that may be overstating the downside protection that the industry enjoys, it's true that waste services tend to be insulated from downside pressures. WM enjoys some big advantages because of its scale. For instance, it's able to negotiate large national corporate accounts that smaller rivals can't touch, and it can make more efficient bids because it's a fully integrated firm (it owns its own landfills and can spread costs across more operations).

Waste Management is another good example of a heavily shorted high-yield name whose dividend should be a factor in how long short sellers stay the course. Right now, the firm's short interest ratio sits at 10.32, which means that it would take more than two straight weeks of buying for shorts to exit their positions at current volume levels.

AutoZone

$17 billion auto parts retailer AutoZone (AZO) hasn't been the sort of name you'd want to be short in 2014. Since the calendar flipped to January, AutoZone has rallied 11.6%, nearly doubling the performance of the S&P 500. And with some stiff tailwinds pushing at its back, there's good reason to expect more outperformance in the second half of the year.

>>5 Stocks Ready for Breakouts

AutoZone is the top aftermarket car parts retailer in the country, with more than 4,700 stores spread across the U.S. AZO also operates 300 locations in Mexico and a few locations in Brazil. Here at home, the average age of cars on the road is higher than it's ever been -- 11.4 years -- and that means that cost-conscious consumers need to turn to aftermarket parts retailers such as AutoZone in larger numbers. That situation is magnified in AutoZone's Latin American markets, where an even older average fleet age increases the parts demand. The firm's big exposure to private label brands means that AZO earns net profit margins well into the double digits, an unthinkable level of profitability for most retailers.

Retail isn't AZO's only business, though. AutoZone also operates more than 3,000 commercial parts centers inside its retail stores, supplying professional car repair businesses with parts and its proprietary ALLDATA auto repair software. Right now, shorts are piling into AZO. The firm's short interest ratio is 10.08 and rising.

Kohl's

There's no two ways about it: Investors hate $10 billion department store chain Kohl's (KSS) right now. With a short interest ratio of 13.67, KSS isn't just the most-shorted large-cap name on our list this week -- it's also sporting the highest short interest in the company's history. As I write, approximately 25 million shares of KSS are short.

>>5 Toxic Stocks You Need to Sell in July

Kohl's is a big-box department store with more than 1,160 locations spread across the country. The firm's focus is value, offering middle-income consumers well-known brand names at moderate prices. But Kohl's does things a little differently than its similarly-positioned peers: for instance, it doesn't anchor its stores at shopping malls. And instead of courting deals from premium-priced brands, KSS has pursued exclusive celebrity and designed-backed labels for its stores, moves that have dramatically boosted KSS' margins and customer draw. Today, around half of Kohl's sales come from its own private-label brands.

Financially speaking, Kohl's balance sheet is in good shape. The firm currently carries just over $700 million in cash, offsetting a $4.8 billion total debt load. That's about 25% less balance sheet leverage than the industry average, and it helps the firm maintain a hefty 3% dividend payout. Look for Aug. 11 earnings as a potential short squeeze catalyst in KSS.

Rockwell Collins

Aerospace and defense firm Rockwell Collins (COL) rounds out our list of short-squeeze candidates this week. Even though COL has maintained a modest lead on the S&P 500 year-to-date, shorts are piling into the $10.7 billion firm as its share price tests new highs. Here's why shorts should be wary about this name.

Rockwell Collins is one of the leading avionics, flight control and navigation systems suppliers. The firm's equipment can be found on most modern commercial aircraft, as well as larger corporate transport jets (the fastest-growing category in fixed-wing general aviation for the last several years). Avionics is a tough business with huge switching costs. Between FAA approval and manufacturer integration costs, the chances of an aircraft manufacturing jumping to a rival product are hugely mitigated. Honeywell (HON) is the only avionics name that realistically competes with COL for its segment of the aviation market.

Historically, COL's sweet spot has been in regional jets, but important contracts on larger heavy transport aircraft could open up a big untapped market for Rockwell Collins, especially as airlines begin upgrading aging (and fuel-inefficient) models with newer planes. The combination of commercial and defense revenues gives COL attractive diversification from the cyclical nature of the aerospace sector. Right now, the firm's short interest ratio sits at 11.15; July 22 earnings could provide a short squeeze catalyst.

To see these short squeezes in action, check out this week's Short Squeezes portfolio on Stockpickr.

-- Written by Jonas Elmerraji in Baltimore.

RELATED LINKS:

>>5 Stocks Under $10 Triggering Breakout Trades

>>3 Huge Stocks on Traders' Radars

>>4 Stocks Rising on Unusual Volume

Follow Stockpickr on Twitter and become a fan on Facebook.

At the time of publication, author had no positions in the names mentioned.

Jonas Elmerraji, CMT, is a senior market analyst at Agora Financial in Baltimore and a contributor to

TheStreet. Before that, he managed a portfolio of stocks for an investment advisory returned 15% in 2008. He has been featured in Forbes , Investor's Business Daily, and on CNBC.com. Jonas holds a degree in financial economics from UMBC and the Chartered Market Technician designation.

Follow Jonas on Twitter @JonasElmerraji