This is Why Short-Sellers Flock to AT&T Inc. But Avoid Verizon Communications Inc.

AT&T is one of the Dow's most shorted stocks, while Verizon attracts far fewer negative bets. What's the game-changing difference here?

May 2, 2014 at 2:00PM

Short-sellers are treating the two megatelecoms on the Dow Jones (DJINDICES:^DJI) index very differently. AT&T (NYSE:T) is one of the Dow's most shorted stocks, while Verizon (NYSE:VZ) is nowhere near that questionable honor. So what's the difference between these sector rivals? Why do short-sellers swarm to AT&T like moths to a flame, while treating Verizon like a scary citronella candle?

First, the basics. AT&T is the third most shorted stock on the Dow, with 3.8% of shares sold short nowadays..

Verizon only has 1.1% of its shares on loan to the shorting crowd. That's below the Dow average and median short-sales ratios. It's also not far from the least shorted Dow stock, which has 0.7% of its shares in the form of negative bets.

Put another way, AT&T attracts 3.5 times as much short-sales interest as Verizon.

This is by no means a permanent situation. Short interest in these two stocks has tended to move in tandem over the long term. Earlier this year, Verizon had a higher shorting ratio than AT&T:

VZ Percent of Shares Outstanding Short Chart

VZ Percent of Shares Outstanding Short data by YCharts.

You see that sharp hockey-stick change in Verizon's short interest? The sudden twist in the middle of February?

That's where the game changed. Verizon closed the buyout of the Verizon Wireless joint venture from longtime minority partner Vodafone (NASDAQ:VOD). The $130 billion transaction included printing 1.27 billion new Verizon shares, which now belong to Vodafone and its shareholders.

VZ Percent of Shares Outstanding Short Chart

VZ Percent of Shares Outstanding Short data by YCharts.

With 45% more Verizon shares in circulation overnight, the short ratio automatically plunged. But that's not the whole story.

Seeing Verizon's business model complete a radical makeover, the shorters changed strategy. The company now has 100% control over how to run its wireless business, and takes home all of the profit from its most successful operation. No more sharing influence, responsibility, and cash with Vodafone.

A ton of risk disappeared when that transaction closed -- and share borrowers started closing their positions.

Vz Short Interest Chart

By contrast, AT&T had no such positive catalyst this spring, nor did it introduce an avalanche of newly printed shares into the market. From the middle of February to the middle of April, AT&T's short interest grew by 15% while 63% fewer Verizon shares were borrowed in the name of short-selling.

At this point, Verizon is growing faster than AT&T, and analysts expect this trend to continue for the foreseeable future.

VZ Chart

VZ data by YCharts.

The Vodafone buyout of the wireless business was a game changer for Verizon. It was also a very effective short-sales repellent. Both stocks have underperformed the Dow over the last one, three, and five years. But both Wall Street analysts and short-selling investors currently agree that Verizon's future prospects outshine its largest rival.

That doesn't make Verizon an automatic market-beater. The entire telecom industry is in a massive state of flux right now, with smaller rivals making a concerted move on the duopoly at the top.

Furthermore, none of our Foolish newsletters currently own or recommend either Verizon or AT&T. Both stocks score a middling 3 out of 5 stars in our CAPS system, which means that your fellow individual investors aren't terribly impressed by them, either. Other than their generous dividend yields, it's hard to find any reason to get excited about either one of these stocks right now.

Your analysis may vary, of course, which is why Fools always do their own homework. The shorting data above could indeed tip your investing decision in Verizon's favor. Feel free to share your insights in the comments box below.

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Anders Bylund has no position in any stocks mentioned. The Motley Fool recommends Vodafone. Try any of our Foolish newsletter services free for 30 days.

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.

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