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2 unloved stocks to watch

Jim Chanos is an American hedge fund manager and is the president and founder of Kynikos Associates, a company that is focused on short-selling.

Short-selling requires a twist in traditional thinking whereby one sells a stock with a view to buying it back at a lower price. The fundamentals of profitable trading still apply — buy low and sell high.

Mr Chanos made a name for himself when he bet against Enron when no one else would and currently he is focused on selling all things China. After a suggestion that he had never travelled to mainland China, he famously replied, “Well hell, I didn’t work at Enron either.”

So where may the ordinary investor profit from this short selling. Firstly, by keep an eye on the daily top 10 shorted stocks on the Australian Stock Exchange. Secondly, for those stocks which you have gained a thorough understanding over time, wait for a positive industry wide or stock specific announcement.

Upon this announcement or event, “scrambling to cover their shorts” is a mildly humorous term to explain the outright panic short sellers get into when they need to rapidly purchase back stock.

Upon perusing today’s top 10 most shorted stocks two standout opportunities sprang to mind.

1. Western Areas (ASX: WSA)

This is a high quality, low-cost producer that it is often touted as the premier Australian nickel stock. Its shares were trading above $7.00 in March 2012, but today are trading around $2.20.

Its core asset is the 100% owned Forrestania Nickel Project, 400 km east of Perth, Western Australia. Flying Fox and Spotted Quoll are its two operating mines, producing approximately 25,000 tpa nickel in ore.

The opportunity: On the same day as Western Areas is on the top 10 short sold stocks, Macquarie Equities has re-iterated its outperform rating  with a $4.00 price target, based on Indonesian government plans to ban nickel ore exports from January 2014. The announcement is in line with the brokers positive long term view on nickel.

It may also be a matter of time before BHP Billiton (ASX: BHP) announces the divestment of its Nickel West assets. Such a move could potentially trigger consolidation frenzy among junior nickel producers in Western Australia. Additional support to the current share price would also be provided should the Australian dollar continue its recent slide.

2. Cabcharge (ASX: CAB)

The taxi service and bus fleet operator is currently using technology to enhance the customer experience for both travel payment and reservation booking.  Lately it has been affected by reduced corporate and government customers, along with the effects on the wider community of a sluggish economy.

The opportunity: Similar to Western Areas, the company today received a broker upgrade. They are not expecting the headwinds to abate soon, but even under a worst case scenario the valuation is compelling based on a 7.5% dividend yield and there is potential for up to 16% upside in share price with a full cyclical recovery. Additionally, a bottom may have been reached due to minimal ongoing regulatory risks and substantially reduced competition in the payments industry.

Foolish takeaway

In my opinion, it an opportunistic time to pick up two quality stocks with the potent mix of a low prevailing price, short selling activity and increasingly positive broker reviews.

Of course, should you agree with legendary short seller Jim Chanos’s view on China, Western Areas would be best avoided, as most commodity stocks would decline in price.

 

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Motley Fool contributor Mark Woodruff does not own shares in any of the companies mentioned in this article.

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