4 Short-Squeeze Plays in the Tech Sector

Technology companies are often misunderstood by Mr. Market, which leads to some tempting imbalances between the real and perceived values of their stocks.

Today, I'm turning my eye on stocks that seem ripe for a serious short squeeze: They're all top-notch businesses with a ridiculous amount of short-selling action on the stocks.

Company

Market Cap (in Millions) 

% of Shares Shorted

Days to Cover

CAPS Rating (Out of 5) 

IPG Photonics (NASDAQ:IPGP)

$691

4.6%

9.4

*****

FLIR Systems (NASDAQ:FLIR)

$3,986

13.3%

12.0

*****

L-1 Identity Solutions (NYSE:ID)

$955

14.6%

16.0

****

Quality Systems (NASDAQ:QSII)

$816

21.3%

17.9

*****

Data swiped from Capital IQ, a division of Standard & Poor's.

To put the numbers in perspective, Google (Nasdaq: GOOG  ) , with its traditionally high-flying ways has invited only 1.6% of the outstanding stock to the short-sales party, and it takes about half a day of trading at average volumes to cover a stampede of panicking shorts there. Baidu (Nasdaq: BIDU  ) isn't much of a squeeze candidate, either, despite a 14.2% short ratio. Its massive trading volume would let all the shorties get out in about four trading hours.

How can short squeezes make me richer?
The companies in our list, however, don't have that kind of volume cushion to dampen the effects of a short-seller buyback frenzy, so it would take many days or even weeks of normal trading activity to let all of the upside-down investors get out of an uncomfortable position.

Let's say that IPG lands a massive fiber laser supply contract, and the deal stands to double the company's cash flows overnight. Without the short squeeze effect, that news should just about double the stock price overnight. (Remember, this is a pie-in-the-sky what-if exercise, OK?)

When you include the short ratio in the equation, the price change will be much larger. Why? Because the short sellers essentially lost their entire investment in one fell swoop and now stand to make nearly unlimited losses if they hang on to this rising stock star. So they panic, put in their "buy" orders to cancel the short sale, and end up overpaying just to settle the score. The price spike is very short-lived if the trading volume is high, but it can linger on when the sellers are in short supply.

Safety first
Of the four candidates listed here, I'd like to spotlight L-1 Identity Solutions in particular. The company specializes in secure identity documents and identification services and already gets plenty of business from the U.S. government, through printing passports and driver's licenses, among other things.

Today, L-1 is profitable -- many of its competitors are not -- and has more than doubled its revenue two years in a row, with more than 40% growth expected this year. Yes, the stock is a bit expensive, but the company can walk the talk. Moreover, L-1 is just now coming out of a multiyear funk, which can leave the analyst gang flat-footed on occasion -- and that sets the stock up for even stronger price fluctuations.

Any of our four candidates here today could very well trigger a short squeeze the next time they report good news, and would make a good starting point for further investigation. For starters, our CAPS players love 'em all and have a lot of comments to share. Sign up for a free account today, and start digging for hidden treasures.

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