The Dow's 5 Most Loved Stocks

So far 2014 may not be everything the optimists had expected, with the Dow Jones Industrial Average (^DJI 0.06%) off almost 1,000 points from its all-time high set at the end of 2013, but that hasn't done much to derail the bull case that the U.S economy is improving.

The bull thesis has a lot of support behind it. The U.S. unemployment rate ticked downward to 6.6% in January, signaling that job seekers are having an easier time finding work and that businesses are willing to take on risks by expanding. Historically low lending rates have been another key driver of U.S. economic growth, spurring consumers to buy homes and businesses to add workers. Even the housing industry has shown remarkable strength, with home prices up nearly 14% year over year as tight inventory controls have created a demand scarcity. All told, these factors helped U.S. third-quarter GDP growth come in at a robust 4.1%.

Sometimes, though, no amount of growth will ever be enough for skeptics. As I noted yesterday, a number of factors could impede the Dow Jones' rise, including:

• An increasing number of stock buybacks and enterprise cost-cutting, which may be hiding weaker organic growth.
• Artificially low interest rates caused by the Federal Reserve's ongoing economic stimulus, which is spoiling the U.S. consumer.
• A falling labor participation rate, which demonstrates fewer people are joining the workforce and could signal that unemployed workers are simply getting discouraged and dropping out.

Despite this group of dissenters, there exists a select group of "most loved" Dow components that short-sellers wouldn't dare bet against. That's why today, as we do every month, I suggest we take a deeper dive into these five loved Dow stocks. Why, you wonder? Because these companies offer insight as to what to look for in a steady business so we can apply that knowledge to future stock research and hopefully locate similar businesses.

Here are the Dow's five most loved stocks:

Source: S&P Capital IQ.

General Electric
Why are short-sellers avoiding General Electric?

• One of the best defenses against pessimism is diversification, and few companies within the Dow Jones offer a more diversified product portfolio than General Electric. GE shareholders have steadily witnessed the credit quality of its financial arm improve as energy and aerospace contracts have piled up. In addition, GE's dividend, while still markedly lower than its all-time high, has been slowly rising. Since short-sellers are on the line for paying this dividend, GE has created an environment that is quite hostile to pessimists.

Do investors have a reason to worry?

• Unless we see an extremely rapid deterioration in General Electric's loan portfolio, or the overall economy dips into a moderate recession, investors shouldn't concern themselves with GE's day-to-day activities. General Electric's fourth-quarter report, released three weeks ago, demonstrated solid bottom-line growth with earnings per share up 20% as total revenue gained 3%. Specifically, GE saw revenue up by double-digits in six of its nine growth markets, signaling to me that these markets could shield the company from a lot of downside if U.S. growth slows down. Finally, GE's financial arm saw its estimated tier 1 common ratio improve 1.2% to 11.4%, implying improved liquidity. If I were a short-seller, I'd consider packing my bags and looking elsewhere. 

Procter & Gamble
Why are short-sellers avoiding Procter & Gamble?

• Consumer goods giant Procter & Gamble, best known for Tide detergent and Crest toothpaste, uses the inelastic demand for its products to its advantage, allowing for few discounts and heavily focused marketing campaigns to improve brand awareness. Because products such as toothpaste and detergent are needed regardless of how well or poorly the U.S. economy is performing, P&G's cash flow is rarely going to have wild fluctuations. In short, this means P&G is a relatively boring, low beta, cash flow machine, which is exactly the opposite of what a majority of short-sellers are looking for in a stock.

Do investors have a reason to worry?

• Between 2009 and 2013, when now-former CEO Bob McDonald was leading P&G in circles, I would have said pessimists had a shot of being right. During McDonald's tenure, Procter & Gamble paid billions in advertising annually and saw little, if any, bottom-line benefit. With A.G. Lafley now back at the helm, P&G looks like a tiger ready to roar. For fiscal 2014, P&G has stuck by its forecast of 3%-4% organic sales growth and 5%-7% core EPS growth due to an ongoing share repurchase program. Tack on a 57-year streak of dividend increases and you have more than enough catalysts to keep short-sellers at bay. 

Chevron
Why are short-sellers avoiding Chevron?

• Short-sellers have kept their distance from Chevron because growing energy demand in the U.S. and emerging markets is increasingly likely to support higher oil, natural-gas, and liquid-natural-gas pricing in the future. Because Chevron has energy investors' bases completely covered -- from exploration and production to pipelines to refining -- chances are that at least one of its energy operations is excelling at any given time. Considering that it's also a dividend aristocrat, having increased its annual dividend in 25 or more straight years, short-sellers have been given every reason to avoid Chevron.

Do investors have a reason to worry?

• This is one case where what's on paper and what actually happened are miles apart -- at least this past quarter. Chevron, which already warned Wall Street that a weak fourth-quarter was brewing, reported rather sanguine results last week which highlighted a 32% decline in profit and a steep 58% drop in refining income as maintenance picked up and production dropped off. Over the long term Chevron's assets and importance to the energy industry are unquestioned, with the company boasting enormous natural gas deposits off the coast of Australia and capable of producing billions in free cash flow annually. In the near term, however, short-sellers may find some chinks in Chevron's armor as refiners struggle with poor margins and a tough production environment. 

United Technologies
Why are short-sellers avoiding United Technologies?

• Pessimists tend to shy away from United Technologies for many of the same reasons that they dislike General Electric -- namely, business diversity. With products ranging from elevators to aerospace components, United Technologies gives investors plenty of ways to swing for a home run. This means that if one segment is weak, there's a chance for another operational segment to make up for that weakness. Tack on a modest 2% yield, and short-sellers have taken the hint to stay away.

Do investors have a reason to worry?

• Barring a severe decline in government spending or a moderate economic recession, United Technologies shareholders likely have little to fear. The company's fourth-quarter report, delivered two weeks ago, noted a whopping 53% increase in year-over-year adjusted EPS despite only a modest 2% increase in revenue and 4% organic growth. Perhaps United Technologies' greatest growth opportunity remains its large commercial engine segment which saw sales spike 20% during the fourth quarter to $4.1 billion. At 14 times forward earnings, the company isn't exactly cheap given an organic growth rate of just 4%, but it's not giving short-sellers many catalysts to work with, either. 

Nike
Why are short-sellers avoiding Nike?

• Although Nike has had a rough start to the year, short-sellers have kept their distance from the sports apparel giant, largely due to its incredible brand value and expected emerging-market opportunities that should lead toward sustainable mid-to-high single-digit growth. According to research company Interbrand, Nike's brand value rose 13% in 2013, making it the 24th-most valuable brand in the world. The thing with well-known brands is they don't have to do much in the way of advertising, as their products often sell themselves. That's bad news for Nike's peers -- and a good reason for pessimists to stay away. 

Do investors have a reason to worry?

• Based on Nike's track record of stepping over its competitors, there's probably not a lot of ground for short-sellers to walk on. Nike's most recent quarterly report, released in December, delivered an 8% improvement in revenue as worldwide future orders rose 12%. Profit, however, was up a more modest 4% and the company continued to struggle in China where revenue was up just 5%. Once Nike figures out China it's going to be practically unstoppable. In the meantime, I would still suggest pessimists avoid betting against the swoosh!