How to Turn a Profit by Buying “Bad” Companies

Turn a Profit by Buying “Bad” CompaniesGroupon, Inc. (NASDAQ/GRPN) is up a sizzling 368% from its 52-week low of $2.60 on November 12, 2012. Many in the market thought Groupon was dead. I was not one of them; I actually saw a possible short-covering opportunity due to the massive short-selling position on the stock. All the company needed was some good news to drive the shorts to cover. Of course, this happened as Groupon reported positives in its business and strong results. The current short-selling position is 5.6% of the float as of August 30, versus 15.3% in February.

I usually view these intensive short-selling buying opportunities as a contrarian play in a company that the stock market may have judged wrong.

The key to short-selling buying success is to look for companies that have strong fundamentals but may be struggling with some poor results that can be dealt with. Of course, you won’t always be correct, but if you minimize the losses and ride the gains, then you’ll get good results.

Facebook, Inc. (NASDAQ/FB) was another case of a company with some difficulties following its initial public offering. (Read “Why Social Media Stocks Are Back on Top, Getting Stronger.”) The company had to convince investors that it could monetize its one billion users. Facebook focused on the mobile advertising market and was able to turn things around. The stock, under heavy short-selling pressure, quickly reversed course from its $18.80 low in October 2012, moving above $50.00 on Thursday.

Electric-car maker Tesla Motors, Inc. (NASDAQ/TSLA) was also seen as a fad by Wall Street and investors, as short-selling swarmed the stock. Yet the company was able to generate some excitement with its sales and plans, and the stock took off from $26.00 in October 2012 to the current $190.00 range. And if the company can still deliver, I would expect more gains to come, as the current short position is at 34.5% of the float, or 21.56 million shares.

While short-selling buying opportunities like Groupon, Facebook, and Tesla may be rare, they do happen.

In the small-cap area, you may want to consider taking a look at Blyth, Inc. (NYSE/BTH), a seller of consumer goods via direct selling and catalogs. There could be a great contrarian opportunity here, with a major short interest of 5.41 million shares shorted as of August 30, 2013, or a whopping 56.8% of the float, according to Thomson Financial.

In the youth clothing segment, consider looking at Aeropostale, Inc. (NYSE/ARO), which had a short position of 25.4% of the float as of August 30, 2013, or 14.58 million shares, according to Thomson Financial. The stock could surge if it reports better results.