Earnings This Week: 5 Highly Shorted Stocks With Significant Covering

Earnings season is a tricky game for investors hoping to ride the waves of blowout earnings and dashed hopes. If done correctly investors can see big rewards, but the potential for failure is just as large.

For instance, a company can beat the analyst expectations, but miss the “surprise” consensus, and the stock can plummet. The “surprise” consensus is an unofficial idea investors assume of how much the earnings will beat expectations. It is a purely psychological phenomenon of the markets.

Because of the many factors, it is imperative that investors hedge as much risk as possible to eliminate the “gambling” aspect of earnings season. One way some traders do this is to find stocks that are highly shorted, but seeing increased covering.

Highly Shorted Stocks With Significant Covering, Explained

Short selling implies a bet that share prices will fall, in which case the short seller earns a profit. Short sellers also lose money when share prices rise, so looking at the prevalence of short seller activity around a stock provides a good idea of how the investment community’s feels about its prospects.

For the list below we searched for stocks reporting earnings next week, and looked among them for names with a high level of short positions.

While this is a pessimistic screen, we added one more layer that may indicate an earning surprise wouldn’t be far-fetched: Increased short covering month-over-month.

The logic here is that while a large number of investors are feeling pessimistic about the stock, more are becoming less pessimistic – indicating they think the stock has more upside than downside to price in over the coming days and weeks.

And here’s an interesting consideration: If share prices are going up for whatever reason, those still with short positions will want to close them out (short covering, or buying back shares at market price) to minimize their losses. This creates excess demand for the stock, which causes prices to increase even higher than they would have otherwise. For a shareholder, this means even bigger gains.

Short selling = BEARISH perspective on the stock. Short covering = BULLISH perspective on the stock

Business Section: Investing Ideas

Below is a list of stocks we put together using the ideas above. They all meet these criteria:

- Reporting earnings this week (Oct 16-19)
- Short float above 15% (short float: the percentage of available shares to trade that are in short positions)
- Experiencing short covering over the last month (pessimism is subsiding)

In addition:

- Market cap over $300 million
- Share price over $1

How do you think these names will fare their earnings announcements?

List sorted by earnings date.

1. Apollo Group Inc. (APOL, Earnings, Analysts, Financials): Provides educational programs and services at the undergraduate, master’s, and doctoral levels. Market cap at $3.25B, most recent closing price at $28.64. Float short at 16.02%. Earnings date: 10/16/12 Shares shorted have decreased from 17.35M to 15.71M over the last month, a decrease which represents about 1.64% of the company’s float of 99.85M shares. Days to cover ratio at 8.65 days.

2. USG Corporation (USG, Earnings, Analysts, Financials): Engages in the manufacture and distribution of building materials worldwide. Market cap at $2.26B, most recent closing price at $21.06. Float short at 23.7%. Earnings date: 10/18/12 Shares shorted have decreased from 22.68M to 21.76M over the last month, a decrease which represents about 1.24% of the company’s float of 74.28M shares. Days to cover ratio at 7.49 days.

3. Briggs & Stratton Corp. (BGG, Earnings, Analysts, Financials): Designs, manufactures, markets, and services air cooled gasoline engines for outdoor power equipment worldwide. Market cap at $889.82M, most recent closing price at $18.60. Float short at 19.65%. Earnings date: 10/18/12 Shares shorted have decreased from 9.96M to 9.17M over the last month, a decrease which represents about 1.8% of the company’s float of 43.81M shares. Days to cover ratio at 27.66 days.

4. McMoRan Exploration Co. (MMR, Earnings, Analysts, Financials): Engages in the exploration, development, and production of oil and natural gas offshore in the Gulf of Mexico and onshore in the Gulf Coast area of the United States. Market cap at $1.92B, most recent closing price at $11.86. Float short at 22.43%. Earnings date: 10/19/12 Shares shorted have decreased from 24.30M to 22.53M over the last month, a decrease which represents about 1.85% of the company’s float of 95.62M shares. Days to cover ratio at 9.6 days.

5. magicJack VocalTec Ltd. (CALL, Earnings, Analysts, Financials): Market cap at $390.54M, most recent closing price at $20.11. Float short at 35.54%. Earnings date: 10/19/12 Shares shorted have decreased from 4.06M to 3.66M over the last month, a decrease which represents about 4.73% of the company’s float of 8.46M shares. Days to cover ratio at 13.37 days.