Will Pessimists Crush These 3 Most Hated S&P 500 Stocks?

Time marches on, and so does the S&P 500 (SNPINDEX: ^GSPC  ) . America's broadest-based index has seemed practically unstoppable during the past five years, as the U.S. economy has regained its footing and corporate earnings continue to head higher.

As I've noted in recent days, the biggest factor that's aided in the market heading higher is the steady decline in the U.S. unemployment rate, which hit just 6.3% last month, its lowest level in more than five years. A declining unemployment rate is imperative to the health of the U.S. economy because U.S. GDP is so dependent on consumer spending to grow. If more of the unemployed are finding work, it could lead to more disposable income, and the potential for U.S. GDP to expand even further.


Source: Emmanuel Huybrechts, Flickr.

Also helping the optimist's case is the fact that nearly all economic indicators have picked up following two months of tepid growth directly tied to the polar vortex. Fears of an endemic slowdown appear to have been overblown, with factory orders hitting an all-time high earlier this week, and manufacturing readings continuing to improve.

However, you won't find all investors in the optimist's camp. In fact, there are more than enough reasons for pessimists to believe that the S&P 500 is teetering on the edge of a sizable drop.

At the center of the bearish thesis is the fact that most companies have turned to cutting costs and buying back their own shares in order to mask a lack of top-line growth. According to research firm FactSet, which tracks the earnings performance of all S&P 500 companies, revenue growth for Q2 is expected to come in at 3.1%, which is below the 3.7% that had been predicted by Wall Street at the beginning of the quarter. Furthermore, FactSet notes that there have been considerably more earnings warnings in Q2 than in past years, which may signify that the S&P 500's run could be nearing an end. Simply put, short-sellers understand that cost-cutting and share buybacks aren't a long-term solution to a lack of organic growth, and pessimists are merely biding their time until they're right.

Keeping these concerns in mind, I suggest we do what we do every month: take a deeper dive into the S&P 500's three most hated stocks. Why, you ask? Because this way, we can better understand what characteristics, if any, attract short-sellers so that we can avoid buying similar companies in the future.

Here are the S&P 500's three most hated companies:

Company

Short Interest as a % of Outstanding Shares

GameStop (NYSE: GME  )

27.70%

U.S. Steel (NYSE: X  )

25.87%

Joy Global (NYSE: JOY  )

21.03%

Source: S&P Capital IQ.

GameStop
Why are investors shorting GameStop?

  • The primary reason short-sellers have piled onto GameStop, the nation's largest bricks-and-mortar game and game-accessories retailer, is due to the belief that its recent same-store growth is unsustainable. At the moment, GameStop is benefiting from a perfect scenario whereby both Microsoft and Sony launched new gaming consoles for the first time in eight years. Game enthusiasts literally can't get enough of these new consoles and games. However, pessimists anticipate that the company will be facing some incredibly tough same-store sales comparisons next year that it likely won't be able to match. In addition, GameStop sales are at risk from digital competition due to the convenience of simply streaming content to your PC or gaming console from the comfort of your own home.


Source: GameStop.

Is this short interest warranted?

  • On one hand, the demise of GameStop was largely overstated. In its first-quarter results, released two weeks ago, global sales jumped 7%, to $2 billion, while comparable-store sales grew 5.8%. The biggest boost came from its hardware category, with sales up a whopping 81.8%. However, skeptics had plenty of fodder to chew on, as well. More importantly, with games moving toward a digital platform, GameStop noted a non-GAAP increase in digital receipts of just 9.5%. As of Q1, digital and mobile/consumer electronics sales combined only equaled 7.9% of GameStop's total revenue, and that's simply unacceptable if the company is gearing up to thrive during he next 20 years. Given the fact that it takes years for gaming companies to develop new consoles, I don't believe GameStop's surge will take it much beyond the next quarter or two. Short-sellers may indeed be looking at a solid profit opportunity here during the coming years.

Souce: U.S. Steel.

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

  • Huge short interest in U.S. Steel is nothing new, as the company has carried double-digit levels of short interest for years. Skeptics have built a sizable position in the company based on the idea that global steel oversupply could pressure prices and hurt U.S. Steel's margins. Also, short-sellers have honed in on the fact that cheaper overseas competition could potentially flood U.S. and European markets, making it tougher for U.S. Steel to sell its steel. Together, these factors have led U.S. Steel to five consecutive annual losses.

Is this short interest warranted?

  • Relative to GameStop, I believe U.S. Steel is even more worthy of the attention of short-sellers. Earlier this week, the company announced its intention to idle two of its tubular steel factories in the U.S. because dumping practices are beginning to adversely affect its sales. This is worrisome because steel prices have actually had a steady rebound during the past year, and shareholders would expect U.S. Steel to expand production rather than scale it back. U.S. Steel's debt is another major concern. The company is currently sporting $2.84 billion in net debt, which focuses nearly all of its efforts on paying interest and debt rather than improving operations, or making earnings-accretive acquisitions. With foreign competition now a tangible threat, I believe short-sellers could end up decisively in the positive with this trade.

Joy Global
Why are investors shorting Joy Global?

  • Lastly, and sticking within the commodities theme, short-sellers have kept up their pressure on Joy Global, a manufacturer of heavy machinery that's primarily used by miners around the globe. As commodity prices have tanked, the urge by miners to expand their production fell off a proverbial cliff, and so have Joy Global's orders. The thought here from short-sellers is that there's no reason to be bullish on Joy Global until mining visibility improves, and commodity prices start heading higher.


Source: Peter Craven, Flickr.

Is this short interest warranted?

  • The real answer to this question depends on what your investing time horizon looks like. For traders looking at the next six months to perhaps even two years, short-sellers may indeed have the upper hand. Visibility in the mining sector is practically nonexistent at the moment, and gold, silver, and iron ore have all made another move lower during the past week. With top-line sales expected to fall by 25% this year, there truly are few reasons for traders to be excited about Joy Global. However, if you're plan is to buy Joy Global and sock it away for 10 years, then I'd suggest your chances at success are pretty high. Joy is well-capitalized, and it possesses the geographic reach and pricing power to grow its earnings rapidly in a favorable commodity environment.

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Related Tickers

10/21/2014 4:34 PM
^GSPC $1941.28 Up +37.27 +1.96%
S&P 500 INDEX CAPS Rating: No stars
GME $40.71 Up +0.05 +0.12%
GameStop CAPS Rating: *
JOY $52.18 Up +1.04 +2.03%
Joy Global, Inc. CAPS Rating: ****
X $36.16 Up +2.19 +6.45%
United States Stee… CAPS Rating: ***

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