The Dow's 5 Most Hated Stocks

It might be tough to imagine this, but the Dow Jones Industrial Average (DJINDICES: ^DJI  ) is 1,148 points below its all-time intraday high set on the final day of trading in 2013. Then again, putting things into perspective, the Dow Jones is also up nearly 8,900 points from its March 2009 closing low set during the height of the recession. In other words, we've certainly come a long way, all things considered.

The Dow Jones -- which is represented by 30 diverse multinational businesses -- and its investors have to give a lot of thanks to the Federal Reserve's ongoing monetary-easing program, which has kept lending rates low and spurred enterprise and consumer borrowing. The effect of low lending rates has been quite evident in the five-year low in the unemployment rate, a double-digit increase in home prices around the country, and the improved credit quality in banks' loan portfolios.

Despite what appear to be clear cut signs of improvement, plenty of skeptics still remain, myself included. As I noted last month, three factors stand out as reasons to believe our current growth rate is masking underlying economic weakness. Those factors are: a falling labor participation rate which is masking a lack of genuine jobs growth, the continuation of Federal Reserve quantitative easing which is spoiling consumers by keeping lending rates artificially low, and a big surge in corporate buybacks and cost-cutting which is masking a dearth of top-line growth.

With this in mind, I suggest we do what we do every month, which is to take a closer look at the Dow's five most hated companies -- in essence, the five stocks with the highest level of short interest -- to better understand what characteristics, if any, are attracting short-sellers so we can avoid buying similar stocks in the future.

Here are the Dow's five most hated stocks.

Company

Short Interest as a % of Outstanding Shares

Intel (NASDAQ: INTC  )

4.29%

Caterpillar (NYSE: CAT  )

3.46%

Verizon (NYSE: VZ  )

3.08%

AT&T (NYSE: T  )

2.87%

IBM

2.58%

Source: S&P Capital IQ.

Intel
Why are investors shorting Intel?

  • It was nice to finally see a small reduction in the number of Intel shares held short month over month, but it's still the Dow's most short-sold stock. The bet against Intel revolves around the company's beefed up investments in mobile processing technology, which is hampering its bottom-line results as PC sales languish. Although Intel is still able to turn hefty quarterly profits, a decline in PC sales is stymieing its ability to grow rapidly, causing short-sellers to believe antsy traders will dive out of the slower-growing chipmaker and into other prominent tech names.

Is this short interest warranted?

  • Skepticism is obviously warranted based on Intel's 2013 performance in which revenue fell 1% for the full year, with the company falling $0.01 shy of Wall Street's earnings-per-share estimates in the fourth quarter. However, I believe there are far too many positives here to consider betting against Intel at these levels. Intel noted in the fourth quarter the beginning of stabilization in PC sales, which have been its primary source of cash flow, while big data center revenue, the next-generation growth segment for Intel, grew by 8%. With Intel's yield approaching 4% and big data center spending rising, there's little reason short-sellers have for piling into Intel here. 

Caterpillar
Why are investors shorting Caterpillar?

  • As I've reiterated in prior months, if there is a company within the Dow Jones that is deserving of being the most short-sold, it's heavy duty equipment maker Caterpillar, which has seen its mining and building operations throttled by weakening demand from China and uncooperative global commodity prices. In fact, Caterpillar lowered its full-year guidance an astonishing three times in 2013, signaling just how uncertain and weak the mining and building sectors had become. Short-sellers are simply making a bet that this weakness and uncertainty will continue for the foreseeable future.

Is this short interest warranted?

  • Shareholders in Caterpillar are probably sleeping with one eye open at the moment -- and with good reason. Although the company delivered a stronger than expected fourth-quarter profit last week on steep cost cuts, and provided a more upbeat 2014 forecast than in previous reports due to a rebound in its heavy-duty building segment, its mining operations are getting weaker than anyone had anticipated. Shareholders certainly don't need to worry about Caterpillar remaining profitable and should understand that it can cut costs and buy back shares as needed to boost EPS. But all this is really doing is masking an extraordinarily weak mining sector. Until the tide turns on commodities, I'm afraid short-sellers are going to remain active in Caterpillar. 

Verizon
Why are investors shorting Verizon?

  • The growing number of short-sellers in wireless service provider Verizon, though, has me a bit baffled. Unlike Caterpillar, which has been delivering weak year-over-year results, Verizon is meeting its estimates and delivering slow but steady growth. What appears likely here is that traders (not long-term investors) are cycling out of slower-growth defensive names like Verizon and chasing growth in the technology and biotechnology sectors as the market heads higher. This cyclical rotation could negatively impact Verizon's share price. In addition, short-sellers could be placing their bets that Verizon overpaid to buy its remaining stake in Verizon Wireless from Vodafone Group for $130 billion.

Is this short interest warranted?

  • Based on Verizon's fourth-quarter results last month, there isn't much to fear from a long-term shareholders' standpoint. During the quarter, Verizon managed to add 1.7 million retail net connections to its Verizon Wireless network as revenue rose nearly 6% to $21.1 billion. Its FiOS additions didn't hit the mark, but all things considered, its wireless dominance is what matters here. Another factor to consider is that Verizon's next-generation 4G LTE network covers more cities than the other three large U.S. carriers combined, giving it a comparative advantage for the moment that short-sellers would be truly foolish to mess with! 

AT&T
Why are investors shorting AT&T?

  • Not to completely rinse and repeat much of the discussion above, but AT&T has garnered much of its short interest from being a slow and stodgy growth story when traders are busy looking for higher growth and riskier investing opportunities. The end result is a rotation out of AT&T and into more volatile names. Also, with Verizon purchasing the final stake in Verizon Wireless from Vodafone, it theoretically has a more rapid long-term growth rate potential than AT&T, causing some investors to believe that Verizon will be the clear winner in the mobile service sector.

Is this short interest warranted?

  • I can understand short-sellers' interest in AT&T just a bit more than their interest in Verizon because of AT&T's slower growth rate, but overall their pessimistic bet makes little sense. In fourth-quarter results released last week, AT&T' delivered sales gains of nearly 2% as its churn rate dipped to a mere 1.1% and the number of subscribers using smartphones rose to 77%, which is actually higher than Verizon, according to Fool contributor Chad Henage. Long story short, AT&T delivered postpaid ARPU growth of 2.1% and shouldn't have any problems keeping pace with Verizon or growing its bottom line. 

IBM
Why are investors shorting IBM?

  • Sort of echoing the commentary on Intel above, Big Blue has run into trouble from the decline in PC sales, which has reduced hardware sales and forced IBM to spend heavily on investing in its next-generation big data center solutions. Increasing competition from Hewlett-Packard, which is aggressively trimming jobs and other costs, isn't helping IBM's situation, either. With IBM's growth temporarily slowed -- revenue fell 5% in the fourth quarter -- traders are once again cycling out of IBM and into higher growth names which could have the effect of pushing IBM's share price lower.

Is this short interest warranted?

  • Once again, I can see where skeptics have gotten the idea that IBM could head lower based on declining hardware sales, but I just don't see much room for any more downside left in IBM's share price -- especially with Warren Buffett's Berkshire Hathaway as a major shareholder. Ultimately, IBM is capable of generating more than $30 billion per year in free cash flow and should see software sales improve by a steady 3%-6% annually, canceling out any declines in PC hardware sales. With plenty of room for further cost-cutting and a forward P/E below nine, I believe short-sellers will be sorely disappointed if they stick with IBM. 

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