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ASX stocks that could outperform as short-sellers capitulate

It often pays to see what short-sellers are up to as the level of bearish bets can often have a significant short-term bearing on the performance of ASX stocks.

While investors often pay attention to the most shorted stocks on the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index, they often neglect to look at stocks where short-sellers are beating a hasty retreat.

Short-selling is the game of selling a borrowed stock in the hope of buying it back at a lower price later to profit from the difference. Short-sellers tend to be more sophisticated compared to the everyday investor – although they don’t always get their bearish calls right.

In that respect, I suspect looking at companies that have recorded a big decline in the number of shares out on loan to short-sellers (called short-interest) could prove to be a more accurate sign of when a stock will recover.

Biggest drop in short-interest

The stock that recorded the biggest drop in short-interest this month is building materials and services group Wagners Holding Company Ltd (ASX: WGN).

The amount of WGN shares shorted fell 169 basis points to 1.62% as at July 15 (ASIC data is always one week behind).

Shareholders will be hoping that the loss of interest of short-sellers will mark a turning point for the stock, which was trading at over $4 a year ago and is currently fetching $1.85.

Short-sellers losing their appetite

Short-sellers are also rushing for the exits in Retail Food Group Limited (ASX: RFG). Short-interest in the embattled food franchisor, which owns brands like Gloria Jean’s Coffees, Brumby’s Bakeries and Donut King, fell 81 basis points since the start of July to just 0.43% as of last Monday.

Chatter about of possible white knight riding to the rescue for the scandal-ridden group has undoubtedly contributed to the short-selling exodus.

The Sydney Morning Herald reported that Soliton Capital is considering injecting $100 million or more to help Retail Food Group repay debt due in the third quarter of this year.

I would be reluctant to join the bulls in buying the stock but those with a higher tolerance for risk may be willing to make a punt.

Steeling for a recovery

The third notable stock gaining ground against short-sellers is the BlueScope Steel Limited (ASX: BSL) share price.

Short-interest in the steel products maker fell 65 basis points this month to 0.41% as an improving outlook for US steel prices have prompted bearish traders to take profit and close positions.

While the Bluescope share price is still down by more than 30% over the past year, it has enjoyed a significant bounce in the last month or so.

I think the stock looks cheap and I believe it will continue to outperform over the short to medium-term.

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Motley Fool contributor Brendon Lau owns shares of BlueScope Steel Limited. Connect with him on Twitter @brenlau.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.