The Dow's 5 Most Hated Stocks

Somehow it seems that practically every month I'm telling you how the iconic Dow Jones Industrial Average (^DJI +0.60%) hit a new high as unemployment levels hit a six-year low, the housing market continues to find its footing, and manufacturing sector growth is coming in well ahead of expectations signaling the potential for stronger economic growth than economists have forecast. Well, guess what? That's exactly what happened again in October!

Historically viewed as one of the markets' weaker months, October delivered more gains for long-term investors with the Dow Jones Industrial Average and its 30 components cumulatively advancing by 2.7% in a month that was plagued by a 16-day government shutdown, fears of a debt default, and the botched launch of Obamacare's federal health exchange, Healthcare.gov.

Yet in spite of the Dow's impressive year-to-date returns, quite a cohort of pessimists still remain out there that feel the overall market is one step from going over the edge. There could be some merit to these views as top-line growth has been tepid at best for most companies with earnings beats coming from reduced expenses and the benefits of share repurchases rather than organic growth in numerous instances.

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.

Source: Intel Free Press, Flickr.

Intel
Why are investors shorting Intel?

• The reason short-sellers have flocked to chipmaker Intel has remained unchanged for months -- a rapid deterioration in PC sales -- yet the overall short interest in Intel rose modestly from the previous month after it reported its third-quarter results. For the quarter, Intel delivered flat revenue growth amid a less than 1% decline in profit. Furthermore, Intel forecasted weak revenue growth in the fourth-quarter which is traditionally its best quarter of the year, presumably because of shrinking demand for PCs. Short-sellers, despite the adjusted EPS beat, have taken this earnings report as further proof that Intel's growth is going to suffer for a few more quarters as it spends heavily on R&D in order to diversify its product line away from PCs.

Is this short interest warranted?

• The one pertinent question when dealing with a short-seller is what sort of timeframe they're looking at to achieve their desired results. Most short-sellers are short-term traders looking for a quick buck. With that assumption in mind, pessimists have a decent shot at possibly making some money on Intel which hasn't been shy that its top and bottom-line will lack growth in the coming quarters due to sluggish PC sales. However, over the long run, Intel's push into cloud hardware and mobile devices like tablets coupled with its legacy free cash flow from its PC business should be more than enough to fuel dividend growth and buoy its share price during this transition.

Caterpillar
Why are investors shorting Caterpillar?

• Of all the Dow components we're going to take a look at today, perhaps none is in worse shape at the moment than heavy duty machinery manufacturer Caterpillar. Weak commodity prices and a slowdown in growth from China has crushed demand for heavy-duty mining equipment and caused Caterpillar to lower its guidance not once, not twice, but thrice this year! In Caterpillar's third-quarter results, released last week, it reported an 18% decline in revenue to $13.4 billion as net income slipped nearly 45% to $946 million. Furthermore, Caterpillar lowered its full-year revenue guidance at the midpoint by about $2 billion and lopped $1 in EPS off as well.

Is this short interest warranted?

• Based on the commentary by Caterpillar CEO Doug Oberhelman, who noted via Reuters, "Any expansion in the near term is dead, it's over, it's not going to happen," I'd say that short-sellers are looking pretty good. This is one of those instances where we know Caterpillar has a strong balance sheet and we know it has the product line and market share to succeed when mining growth does rebound. The only problem: we have no clue when that's actually going to happen. At some point Caterpillar is going to get so cheap on a forward earnings basis that value investors will start buying, but we clearly haven't hit that level yet.

AT&T
Why are investors shorting AT&T?

• Sometimes earnings growth and business stability isn't the issue as is the case with U.S. telecom service giant AT&T. Instead, AT&T is merely a victim of its own industry. With the Dow Jones Industrial Average soaring 19.2% year-to-date, most investors would rather own high growth companies than get stuck in defensive names like AT&T whose stock and business are unlikely to see much benefit in a rapidly advancing market. The thought here for short-sellers is to bet against the stock while this growth rotation is ongoing and presumably make money.

Is this short interest warranted?

• Perhaps a little bit of pessimism is warranted given that it needs to be play catch-up to Verizon with regard to its 4G LTE nationwide rollout, but outside of that aspect AT&T doesn't fit the mold of a stock short-sellers can make a lot, if any, money from. AT&T has a very low beta meaning it tends to move far less than the overall market, is extremely profitable having produced more than $19 billion in free cash flow over the trailing 12-month period, and recently topped Wall Street's third-quarter EPS forecast by $0.01. To add, it also delivers one of the more impressive yields within the Dow at 5%. I'd say this has all the makings of a company short-sellers should be actively avoiding!

Verizon
Why are investors shorting Verizon?

• Not to rinse and repeat, but the story with Verizon is almost identical to that of AT&T as to why short-sellers are betting against it. Verizon's growth rate, thanks to Verizon Wireless, is a bit more robust than AT&T (and likely the reason AT&T has the slightly higher short interest), but it still doesn't have the allure that many high-growth tech companies have. So, like AT&T, short-sellers are pouncing based on the idea of an investing rotation out of defensive stocks and into higher growth names. In addition, there's a slight bit of acquisition related uncertainty surrounding its $130 billion purchase of the remaining 45% stake in Verizon Wireless from Vodafone Group.

Is this short interest warranted?

• Much like AT&T, perhaps a little bit of upside skepticism should be priced in given its monstrous acquisition, but I wouldn't seriously consider betting against Verizon here with a dividend yield of 4.1% and the nation's broadest 4G LTE coverage which acts as a major selling point for signing up and retaining highly sought after wireless customers. Although its high growth days are long gone, I believe it would take nothing short of a deep recession to put a hurting on Verizon's bottom line.

Visa
Why are investors shorting Visa?

• I only have two possible explanations for why traders are betting against Visa. Either one, they're a glutton for punishment, or two, they're expecting the current debit-fee cap of $0.21 per transaction to stay in place which would potentially cap future earnings growth in the U.S. debit-card market for Visa and its primary rival MasterCard. In its fourth-quarter report released just days earlier, Visa delivered just 3% revenue growth as net income retreated 28% from the prior year due to litigation costs. Short-sellers have to be betting on this debit cap staying in place and for ongoing court costs to eat into Visa's bottom line if they want to be successful.

Is this short interest warranted?

• I won't say this very often, but I think short-sellers are out of their minds to bet against Visa. Even with its debit-fee cap gray clouds and litigation costs, it still produced a 13% growth in payment volume to $1.1 trillion while revenue on services grew 10% to $1.4 billion. With 85% of the world's transactions still being conducted in cash Visa has a multi-decade double-digit growth opportunity on its hands, and modest growth in the U.S. markets is certainly not going to hold it back. To add the icing on the cake, Visa also recently boosted its dividend much to the chagrin of short-sellers.