The Dow's 3 Most Hated Stocks

Even following yesterday's 267-point swoon, the Dow Jones Industrial Average (DJINDICES: ^DJI  ) still sits about 9,600 points above its recession lows, which isn't too bad at all.

There are a number of reasons the Dow Jones has vaulted higher over the past couple years, including record-low lending rates that have spurred business expansion and hiring, improved credit loan quality for our nation's lenders, and a rebounding housing industry. Given 4.1% GDP growth in the third quarter and 2.6% in the fourth, most investors can safely assume the U.S. economy is in full swing.


Source: CoffeeandMarkets.com

I say "most investors" because a select group of skeptics, such as myself, believe the market is living on borrowed time. I suspect the main culprit could be the slow drawdown of the Federal Reserve's economic stimulus, known as quantitative easing. This stimulus has been instrumental in keeping long-term lending rates down, but scaling back the Fed's Treasury purchases could push bond prices down and yields up. That could negatively impact the housing industry, as well as overall hiring and business expansion. Not to mention, this quantitative easing cutback comes as corporate cost-cutting and share buybacks are peaking, which may signal they're masking a lack of top-line growth.

With these points in mind, I suggest we do what we do every month, which is take a closer look at the Dow's three most hated companies -- in essence, the three 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 three most hated stocks.

Company

Short Interest as a % of Outstanding Shares

Caterpillar (NYSE: CAT  )

5.4%

Intel (NASDAQ: INTC  )

4.5%

AT&T (NYSE: T  )

3.8%

Source: S&P Capital IQ.

Caterpillar
Why are investors shorting Caterpillar?

  • Short-sellers continue to pick on the maker of heavy-duty construction and mining equipment based on the expectation that commodity prices will remain weak and that lending will rates rise in the interim. Prices of commodities such as gold, silver, and copper help determine whether miners want to up production or boost exploration activity. With commodity spot prices well off their highs mining activity has slowed considerably, as have Caterpillar's orders from its global customers. In addition, a higher-interest-rate environment could slow construction activity, hurting sales to the industrial and commercial markets.

Is this short interest warranted?

  • Following three earnings warnings last year, Caterpillar's latest earnings report actually surpassed the Street's expectations -- but that doesn't mean it's out of the woods yet. While I believe in Caterpillar's long-run pricing power and its global diversity, I don't believe it has any idea what to expect through 2015 with respect to demand or commodity prices. This lack of visibility is a bit worrisome, especially with shares rallying more than 25% from their 52-week low. In other words, some degree of skepticism is warranted, and I fully understand why Caterpillar is the most short-sold Dow component.

Source: Intel.

Intel
Why are investors shorting Intel?

  • Pessimists are at the gates because of slumping PC sales. Intel holds the lion's share of the PC microprocessor market, and that market is shrinking by the quarter as consumers turn toward mobile devices such as tablets and smartphones for their Internet needs. In response, Intel is ramping up research and development of mobile processors and other hardware, but this comes with higher expenses that could hold back profit growth in coming years.

Is this short interest warranted?

  • While I understand where skeptics are coming from given Intel's higher costs, I believe the boat has come and gone on the downside opportunity. Intel is already introducing new cloud-based hardware and processors for mobile devices and tablets that have thus far been well-received. By the end of the decade it's quite possible that Intel could make a third of its revenue from cloud and data center products. Another point to consider is that even though Intel's PC division is shrinking, it's shrinking at a slow enough rate, and it has such robust market share, pricing power, and margin strength, that the cash flow generated from this segment should sustain its premium dividend and R&D for a long time. Intel may not be the screaming buy it once was, but it's certainly not a company I'd have the gall to bet against.

AT&T
Why are investors shorting AT&T?

  • The bet against this telecommunications service giant isn't as cut-and-dried as the previous two companies. AT&T has been caught in the crossfire predominantly because it's a defensive, slow-growth company that investors have been cycling out of in favor of more risk-on investments in the tech and health-care sectors. Also, it's trailing Verizon considerably when it comes to with regard to 4G-LTE capable cities, meaning it'll have to reach into its coffers and spend big in order to catch up. This could stymie its earnings-per-share growth.

Is this short interest warranted?

  • If you took a look at AT&T's latest quarterly report you'd be foolish to consider betting against this telecom stalwart. AT&T announced that its postpaid churn was at a record low for the quarter as it continued to boost wireless revenue and gain new smartphone customers with highly lucrative data plans. Yes, it's probably going to have a hard time keeping pace with the overall market if it continues to move higher, simply because it's a slower-growth established business. However, there's no reason AT&T can't mount 2% to 5% top-line growth year-in and year-out and pay out a premium 5% yield to investors. That alone makes this a company I would suggest you not bet against. 

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