The Dow's 5 Most Hated Stocks

You'd think we'd be out of genie's by now, but the magic just keeps on coming for the Dow Jones Industrial Average (^DJI +2.85%), which continues to eclipse new all-time highs on a somewhat regular basis. It appears that the 16,000 level is but a stone's throw away now!

Leading the charge higher has been incredibly positive news from the jobs sector where weekly jobless claims fell 5.5% to an annually adjusted rate of 326,000, a five-and-a-half-year low. Compounded with word from the Federal Reserve Chairman Ben Bernanke that its bond-buying program, more affably known as QE3, isn't going to be pared back at least in the very near term, and the markets most global companies within the Dow were once again off to the races.

But not everyone is of the opinion that all stocks within the Dow Jones should be heading higher. Weak revenue growth prospects and the potential for higher interest rates are serious concerns that threaten to slow down U.S. economic growth. Five companies in particular have drawn the ire of short-sellers over the past month. Let's have a look at which companies within the Dow are most disliked by pessimists so we can use that knowledge to potentially avoid buying into heavily short-sold companies in the future.

Here are the Dow's five most hated stocks as of the end of July:

Source: S&P Capital IQ.

Alcoa
Why are investors shorting Alcoa?

• As should not be a surprise, for as far back as I can recall, Alcoa handily leads among the Dow's 30 components with regard to investor pessimism yet again. With a big jump in short interest this month, Alcoa's short-sellers see an opportunity to bet that pricing pressures from aluminum oversupply, margin pressures from its idle capacity, and ongoing weakness in China's economy will pressure demand and keep Alcoa's pricing power low. Short-sellers do appear partially justified in their skepticism as revenue fell about 2% in its most recent quarter to $5.85 billion despite higher sales volume.

Is this short interest warranted?

• I'd be foolish to say that it isn't given all of Alcoa's idle capacity and the struggles going on in China to reignite its once fast-paced economy. However, I'm also hard-pressed to find a metal producer with a brighter long-term outlook than Alcoa. The aluminum business is naturally cyclical, but Alcoa has the capacity to ramp up production quickly once pricing power turns in its favor. As emerging markets around the globe whose economies aren't as tied to large industrialized nations like China begin to ramp up their infrastructure build-out, Alcoa could find a surprising stability in its aluminum demand going forward. Alcoa remains a dark horse buy candidate high up on my personal Watchlist.

Intel
Why are investors shorting Intel?

• Intel's growing short presence has everything to do with the ongoing demise of the personal computer and the rise of mobile, Internet-capable devices like smartphones and tablets. With Intel controlling a monstrous 85% of the microprocessor market for PC's it still has a nice chunk of cash flow rolling in, but that amount is steadily shrinking. The thought process here is that if Intel wants to immerse itself in new revenue generating ventures it's going to have to spend big on R&D which will drag down margins and potentially hurt the stock in the interim. Based on Intel's second-quarter results released last month where gross margin dipped 510 basis points from the year-ago quarter, I'd have to say pessimists have so far been spot-on!

Is this short interest warranted?

• I guess it would really depend on your investing timeframe. If you're trying to score a quick buck with Intel in the next six or nine months, then you may have a decent shot at being right. However, over the long run Intel is poised to gain significant cloud-based hardware market share, and could find itself in thick of things as a processing staple in tablets and/or smartphones if it has its way. Capital expenditures are definitely going to be higher over the next year or two as it plays catch-up to its competition, but the dividend growth and cash flow stability should be more than enough to calm skittish investors' nerves.

Source: Zachi Evenor, Flickr.

Caterpillar
Why are investors shorting Caterpillar?

• The negativity surrounding Caterpillar can be explained by weakness in the mining industry in which it supplies heavy-duty construction machinery. With gold, silver, and other mined commodity prices falling to multi-year lows, and China paring back its metals demand on slower-than-expected economic growth, demand for Caterpillar's machinery just hasn't been there. In its recently reported second-quarter results, Caterpillar delivered a 16% decline in sales to $14.6 billion as profit nosedived 43%! Furthermore, it cut its profit outlook for the year yet again and took $3 billion off the top-end of its previously forecasted full-year revenue guidance.

Is this short interest warranted?

• Given how volatile Caterpillar has been lately and how weak metal prices currently are, a growing level of pessimism would certainly be warranted. Over the long haul Caterpillar is not a great company to bet against given its market share dominance in heavy-duty mining machinery. But, over the next year or two, demand disruptions and weak metal prices could leave its customers scrambling and overcompensating with fewer orders that can ultimately hurt Caterpillar's margins. I'd suggest exercising caution with Caterpillar unless you understand that this is a long-term (decade-plus) type play.

Source: illuminating9_11, Flickr.

DuPont
Why are investors shorting DuPont?

• Two factors continue to push short-sellers toward DuPont: a lack of organic growth, and continuing backlash against genetically modified crops by the public. DuPont's lack of top-line growth over the past couple of quarters has been really disturbing, with its titanium dioxide whitening pigment for paint still showing sluggish demand despite strength in housing sales, and the rest of its chemical business largely tied to the health of the currently stagnant global economy. Without a real turnaround in U.S., China, and European sales anytime soon, DuPont's bottom line can only grow based on potential cost-cutting activities, which will only drive it so far.

Is this short interest warranted?

• Again, I'm going to take a middle-of-the-road stance on DuPont. On one hand, without any real catalysts and the ongoing debate on whether GMOs are safe, DuPont looks like a good short-sale candidate. Then again, with a genuine need for higher crop yields and a relatively diverse chemicals business that still provides consistent cash flow, the downside potential for DuPont seems pretty limited. With short-sellers often after the quick buck, they're likely to get bored with DuPont and look elsewhere before too long.

Merck
Why are investors shorting Merck?

• It always seems like a big pharmaceutical company is wiggling its way into the top five most short-sold Dow components each month, and this time it was Merck's turn. Normally Big Pharma stocks are off-limits for most short-sellers because they're rarely volatile and usually pay out substantial dividends thanks to their hefty margins. In the case of Merck, pessimists are probably praying on the fact that its chronic asthma treatment, Singulair, lost patent exclusivity last year and could see sales tumble from a peak of more than $5 billion to just millions within three years. In addition, Merck is slated to lose exclusivity on Remicade, a $2 billion drug, by 2015. 

Is this short interest warranted?

• Patent expirations are the name of the game when it comes to investing in pharmaceutical companies, but I think Merck has plenty in the pipeline to counteract its losses. Next year it'll be filing a new drug application for odanacatib -- a fracture-preventing osteoporosis drug that had its trial ended early by an independent monitoring committee because it was so effective -- and advancing its PD-1 inhibitor, lambrolizumab, which has been designated as a breakthrough therapy by the FDA, through clinical trials. I'd call that a pretty promising pipeline.