For the past few months, small-cap stocks have been the darlings of the stock market. But recently, investors have started to sour on these high-growth, high-risk names.
This raises an interesting question: Does the recent pullback in small-cap stocks offer a good entry point for those who missed out on the rally?
It's a tough question to answer. But the market behavior of more sophisticated traders can be a good litmus test.
Like short-sellers, for instance. They are among the most sophisticated types of investors, so it's worth having a look at what they're doing.
When an investor "goes short," he's actually betting on his stock to lose; instead of buying low to sell high, he's selling high to buy low.
Here's how it works: A short-seller borrows shares from other investors and sells them on the open market. Sooner or later, he has to return them, and closes the short by buying back the same number of shares he initially borrowed.
If he can buy back the stock at a lower price, he turns a profit off the difference.
Short-sellers take on unlimited risk because they have unlimited downside (theoretically, there's no upper limit on the stock's upside) -- if the stock keeps rising, they keep losing. For this reason, they tend to be quite a bit more sophisticated than the average investor -- so if they're shorting a stock, there's a pretty good chance that trouble lies ahead.
That said, if short-sellers cover their positions (i.e., buy back the borrowed shares), it means they think the upside potential of the stock outweighs the downside.
This creates the potential for a short squeeze -- a scenario where demand from short-sellers pushes the stock price higher.
For this list, we wanted to identify the small-cap stocks that have been crushing bearish short-sellers.
To create the list, we started with a universe of about 230 small-cap stocks with significant insider buying over the last six months. To refine the list, we looked at short-seller activity, and identified the small-cap stocks that have seen the largest decreases in short interest over the last month.
Short-sellers and company insiders think the upside potential of these stocks outweigh the downside -- an encouraging signal for those looking to buy small-cap stocks on the dip. What do you think? Use the links below to analyze. (Click here to access free, interactive tools to analyze these ideas.)
1. American Superconductor
2. AMAG Pharmaceuticals
3. RAIT Financial Trust
5. Deer Consumer Products
*Insider trading and short float data sourced from Yahoo! Finance. Data sourced on Friday afternoon, May 27.
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research. Note: The numbers on top of items represent the forward P/E ratio, if available.
Kapitall's Eben Esterhuizen does not own shares of any companies mentioned.
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