The S&P 500's 5 Most Hated Stocks

Apparently not even an actual government shutdown is enough to keep the broad-based S&P 500 (SNPINDEX: ^GSPC  ) down. Remarkably, the S&P 500 has rebounded 151% from its March 2009 lows, and it has shown little signs of slowing down.

At the forefront of its trudge higher has been an improving jobs market where unemployment has steadily declined for four years. Further, homeowners and businesses alike are relishing in historically low lending rates, which have allowed them to refinance existing debt and take on debt for varying new projects. With consumer spending a primary driver of GDP growth, many signs continue to point toward new highs ahead.

Of course, not everyone is in agreement. There are plenty of pessimists lurking around who will gladly point to the upcoming US debt-ceiling debate, which is unlikely to be resolved by mid-October given how divided both political parties are. They'll also guide you towards multiple other complications, like the government shutdown or the implementation of the Affordable Care Act (which carries with it its own set of uncertainties).

Every month we take a look at the S&P 500's most hated stocks in order to better understand what characteristics, if any, attract short-sellers so that we can avoid buying similar companies in the future.

Here's a look at the S&P 500's most hated stocks as of Oct. 1:

Company

Short Interest as a % of Outstanding Shares

J.C. Penney (NYSE: JCP  )

32.52%

Cliffs Natural Resources (NYSE: CLF  )

32.06%

U.S. Steel (NYSE: X  )

29.75%

Pitney Bowes (NYSE: PBI  )

25.59%

Frontier Communications

22.14%

Source: S&P Capital IQ.

J.C. Penney
Why are investors shorting J.C. Penney?

  • Perhaps the better question is: Who in their right mind would consider buying J.C. Penney? This company has been an utter train wreck ever since Ron Johnson took over, got fired, and was replaced by the previous CEO, Mike Ullman, whom Johnson was originally hired to replace. Apparently less bad is better than really bad -- yay, I think! Penney's has produced an average same-store sales drop over the past six quarters of 21.6%, all while burning through its precious cash. Last week the company filed to sell a staggering 84 million shares in order to raise cash. Can we say "dilution"?   

Is this short interest warranted?

  • Goodness, yes! Penney's is diluting its existing shareholders, it still hasn't brought its same-store sales losses below double-digit declines, it doesn't have an answer for its competitors' better performance, and the back-to-school season stunk to high heaven. If Penney's were a comedy act on HBO it would be getting rave reviews. Unfortunately, its maladies aren't meant to be funny, and it looks as if there could be more pain before there's any chance of a turnaround here.

Cliffs Natural Resources
Why are investors shorting Cliffs Natural?

  • With most commodities remaining weak, short-sellers continue to pile into Cliffs, an iron-ore and metallurgical-coal miner. Cliffs, thanks to slowing demand for steel overseas and oversupply in iron ore leading to a dip in prices, was forced to slash its dividend by 76% earlier this year in order to conserve cash. With the stock previously an income investors' haven, the lack of a 5%-plus yield sent the short-sellers pouncing on Cliffs, and they've been unrelenting ever since.

Is this short interest warranted?

  • On one hand, I do understand why short-sellers have piled onto Cliffs Natural; metallurgical coal prices have been weak, and iron ore pricing has been even weaker. In addition, Cliffs' dividend cut didn't exactly inspire confidence in shareholders, or convince them that its cash flow would even stay positive (which it has!). On the other hand, you'll still get about a 3% yield with Cliffs, and the company looks well positioned to take advantage of emerging market infrastructure booms, specifically throughout Asia. Let's just say that if you twisted my arm and asked me if Cliffs was more likely to see $30 or $10 next, I'd choose $30.

U.S. Steel
Why are investors shorting U.S. Steel?

  • It's like déjà vu, but without the profits! Essentially the same factors that are affecting Cliffs Natural are going to have a similar effect on U.S. Steel. Reduced growth prospects in China are weighing on steel supply, while U.S. Steel is boasting very little pricing power and carrying a mountain of debt -- not a good combination, and a good way to draw the ire of short-sellers.

Is this short interest warranted?

  • I believe so. Although we've probably seen the worst that the steel sector has to offer, U.S. Steel hasn't turned an annual profit since 2008, it's generating only minimal positive free cash flow (which isn't allowing it to make much of a dent into its massive debt pile), and it's still struggling to compete against cheaper foreign sources of steel. Eventually U.S. Steel is going to turnaround, but shareholders have been waiting five years for such an event. I simply don't have that kind of tolerance given its many problems, and would recommend looking elsewhere in the steel sector.

Pitney Bowes
Why are investors shorting Pitney Bowes?

  • Short-sellers rarely have to get past the company's profile page before they're sold on betting against Pitney Bowes. The company develops hardware and software for the logistics industry. In other words, it's a big software and hardware supplier to the United States Post Office, among other companies. With physical mail volume slowly dwindling, Pitney Bowes' top and bottom-line figures have followed suit, with Pitney Bowes' robust dividend also getting chopped in half earlier this year.

Is this short interest warranted?

  • Much like U.S. Steel, I believe so. Pitney Bowes may have put the worst behind it for a while -- the $400 million sale of its management division in July allows it to reinvest in R&D and easily support its $0.75/share annual dividend payout. Then again, the sale really didn't solve its growth issues, it just gave the company more time to figure out how to fix its problem. With physical mail shrinking in importance each year, Pitney Bowes is going to need to show a drastic departure from its previously successful lines of operations, and move into the cloud pretty soon -- otherwise short-sellers are likely to push into this stock even further.

Frontier Communications
Why are investors shorting Frontier Communications?

  • As we're in-between earnings reports on Frontier, the key reason short-sellers continue to bet against this stock relates to its ongoing landline attrition. Frontier has done its best to bundle rural customers with broadband and TV packages, but it's been losing landline customers to greater wireless coverage ever since it purchased assets from Verizon in 14 different states. Until that figure stabilizes or reverses, short-sellers just assume that Frontier's free cash flow will shrink and it'll struggle to pay its enormous dividend.

Is this short interest warranted?

  • While the figures don't lie – landline subscribers have been shrinking every single quarter – there has been demonstrable progress in lessening its landline attrition in recent months through package deals. In addition, Frontier has done a good job controlling costs and looks like it has more than enough room to breathe to ensure that its dividend doesn't get cut. I'd still like to see a plan introduced that would help rid Frontier of some of its debt, but I'm more inclined to lean toward optimism than pessimism when it comes to Frontier's long-term outlook, with dividend payments included.

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