The Dow's 5 Most Hated Stocks

It's been an interesting month since the last time we took a long look at the Dow Jones Industrial Average (^DJI 0.63%). In the past three weeks, three companies were booted from the index and the market has welcomed three new stocks with open arms into the blue-chip index.

The change hasn't appeared to have mattered all that much, with the Dow still soaring to near all-time record high levels in recent weeks. The impetus for the rally remains the same as what we saw with the S&P 500: a nearly six-year low in the unemployment rate, an improving jobs picture, rebounding home prices, and the continuation of historically low lending rates which are fueling refinancing and new loan origination activity at favorable rates for consumers and businesses.

Of course, that doesn't mean there isn't another side to this coin. In fact, quite a few investors would throw themselves into the naysayer camp, with the government shutdown potentially going on for much longer than expected, a debt ceiling debate looming in just two weeks with both parties completely divided on everything from which side of the bed they get out of to how to balance a budget, and interest rates beginning to inch higher since May.

Keeping that in mind, I suggest we do what we do every month, which is to take a closer look at the Dow's most hated stocks (i.e., it's most sold short) to better understand what characteristics, if any, attract short sellers so we can avoid buying similar stocks in the future.

Here are the Dow's five most hated stocks:

Source: S&P Capital IQ.

Intel
Why are investors shorting Intel?

• With Alcoa receiving the boot from the Dow, we have a new dubious most hated company in Intel. The reason Intel continues to hover around the 5% short interest mark relates back to the ongoing struggles of PC sales relative to new mobile devices like smartphones and tablets. Microprocessor makers like Intel did see the trends beginning to change, but the rate at which people abandoned PCs in favor of smartphones and tablets really took Intel and Advanced Micro Devices by surprise. In order to counteract this switch, Intel is beefing up its R&D spending on cloud-based hardware and mobile processors, which has the potential to hurt and/or put a ceiling on its profits in the near term.

Is this short interest warranted?

• I'm personally a big fan of Intel and see a lot of long-term potential in cloud-based hardware becoming a big growth driver for its future. In addition, the company's new Atom line of chips should be able to capture (keep in mind this is my best estimate) in the neighborhood of 10% of the mobile processing market. But I also recognize that having to spend heavily on research now means dividend growth could slow for a few years and profit growth could struggle due to higher expenses. If you're looking down the horizon, Intel looks like a great investment you can trust.

Caterpillar
Why are investors shorting Caterpillar?

• Like Intel, we haven't seen a lot change for Caterpillar month over month, although it appears to be in far worse shape over the interim than Intel. Caterpillar, a manufacturer of heavy-duty mining and industrial equipment, is suffering because commodity prices around the globe are well off their highs. With less incentive for miners to mine, Caterpillar has seen a steep drop-off in future orders, which has, in turn, caused the company to dramatically lower its outlook twice this year alone. Short sellers are making a clear bet that things don't turn around for Caterpillar domestically or abroad anytime soon.

Is this short interest warranted?

• Of the five stocks listed here, if I were more inclined to pick a company that should be sold short, it would be Caterpillar. Don't get me wrong: Caterpillar still occupies a dominant position in the global heavy-duty machinery market and another major run in commodities could put this company back on track. However, Caterpillar is also a fairly accurate and forward-looking company and it isn't seeing an improvement in its orders until at least two years from now. That's more than enough cue to perhaps keep your distance and watch from the sidelines until miners are on more solid ground.

Source: Jon Fingas, Flickr.

AT&T
Why are investors shorting AT&T?

• It might seem counterintuitive to short a company as geographically diverse as telecom service provider AT&T, but short sellers are honing in on the fact that relative to Verizon Wireless, AT&T is being left in the dust with regard to 4G LTE-capable cities. Verizon has more than double the number of LTE-capable cities, giving it a definitive edge over AT&T and forcing AT&T to spend heavily to catch-up. Like Intel, higher expenses could reduce AT&T's earnings growth over near term, which is a perfectly good reason for short sellers to be skeptical.

Is this short interest warranted?

• Although AT&T has underperformed Verizon in the growth department and in overall 4G LTE-capable cities, I'm not exactly sure why short sellers would ever bet against AT&T. With a minute beta of just 0.28, AT&T tends not to move much, which should automatically keep short sellers away. On top of this, AT&T pays out one of the top dividends in the Dow at 5.3%. With steady cash flow and a top-tier brand name, I'd suggest not joining these short sellers in betting against AT&T.

Disney
Why are investors shorting Disney?

• M-I-C... K-E-Y... S-H-O-R-T! Jokes aside, the reason it appears that short sellers have piled into Disney in recent months has almost everything to do with its movie studios' performance and its inflated valuation. Specifically, short sellers have cued in on Disney's pitiful take from The Lone Ranger and continue to point at Disney's huge run and forward P/E of 17 as enough reason to presume Disney heads lower from here.

Source: Loren Javier, Flickr.

Is this short interest warranted?

• I certainly feel that much of the optimism surround Disney has been fully baked into its share price. However, I view the optimism and pessimism a bit differently than short sellers. For instance, I happen to see plenty of value in Disney's movie operations despite its Lone Ranger flop and feel growth in its broadcasting segment, vis-a-vis ESPN, will sustain its current valuation. What concerns me, specifically, are Disney's theme parks, which were among its best-performing sectors this past quarter. I just feel that Disney could be squeezing its most profitable once- or twice-a-year customer by again raising ticket prices at its theme parks. Multiple variables, such as weather, work outside of Disney's control at its theme parks, and I'd suggest shareholders consider that before they pony up 17 times forward earnings for the company.

Verizon
Why are investors shorting Verizon?

• Given that we just went through why AT&T shares are being targeted by short sellers, it might be odd to see Verizon on this list as well. With the leading 4G LTE network, you would probably not expect to see Verizon so heavily bet against. However, there are two big uncertainties that keep skeptics coming back. First, the enormous $130 billion purchase of the remaining 45% stake in Verizon Wireless from Vodafone Group is filled with concerns that the company overpaid for the full rights to the brand. Second, the Dow has been shooting higher for the better part of four years now and faster-growing companies have been rewarded. Unfortunately, telecom service providers like Verizon are now often viewed as defensive plays, meaning they tend to underperform in a strong upward-trending market.

Is this short interest warranted?

• Similar to AT&T, I'm struggling to see why there would be a large amount of short interest in these defensive plays in the first place. Sure, they may underperform the broader market in a strong uptrend, but being low beta plays it's odd that they're attracting short sellers, which are usually out for the quick buck. Verizon pays out an index and U.S. Treasury note-topping 4.5% yield and, as mentioned above, has the clear lead in next-generation wireless technology. I believe short sellers should really reconsider before keeping their positions open for too long.