The Dow's 5 Most Hated Stocks

Put aside, for the moment, the fact that the Dow Jones Industrial Average (^DJI +1.24%) swooned a bit to start the New Year, and you have nothing short of a remarkable performance for the iconic U.S. index over the past year.

In 2013, the Dow Jones Industrial Average vaulted higher by 26.5%, nearly three times its historical average annual gain. In terms of attaining new all-time highs, it was the best year the index had seen in about 15 years.

Fueling the index and its 30 components higher was a broad rebound in the U.S. economy, featuring 4.1% GDP growth in the third-quarter, a five-year low in the unemployment rate of just 7%, and ongoing strength in the manufacturing and housing industries, which are encouraging investors that 2014 could be an equally good year.

Yet as we've seen in previous months, not everyone is on board with this rally. In fact, numerous pundits have proclaimed this to be one of the most hated rallies of all-time, if not the most hated. The reasoning behind these claims is solid. As I've noted previously, the number of companies that are topping Wall Street's profit estimates has been consistently high while revenue estimates have been subpar in many instances. In other words, businesses aren't seeing a lot of organic growth and are fueling their bottom-line expansion with stock buybacks, cost-cutting programs, and acquisitions. While this isn't bad necessarily, it's not a sustainable strategy over the long run.

With that in mind, I suggest we do what we do every month, which is to take a closer look at the Dow's five most hated companies -- in essence, the five stocks with the highest level of short interest – to better understand what characteristics, if any, are attracting 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?

• If you compare these figures month-to-month you'll note that Intel's short interest has dropped considerably, and is also likely a reason why Intel recently hit a 52-week high. The short-sale case against Intel revolves around the rapid move away from PCs and toward mobile devices like smartphones and tablets which, before a few quarters ago, Intel had little to no processing presence in. To maintain its hardware dominance, Intel has had to beef up its spending on research and development which, over the interim, reduces its profitability. Short-sellers are counting on this reduced profitability, and Intel's late start into the mobile processing arena, to curtail its share price.

Is this short interest warranted?

• The answer to this question ultimately depends on what you're trying to accomplish by betting against Intel. Over the long run, Intel's superior dividend, legacy cash flow from its PC business, and strong leads in cloud-computing hardware, should buoy its share price. In the short term, though, Intel could struggle to meet expectations as it invests heavily in R&D, meaning short-sellers looking to make a quick buck could have the upper hand. Unfortunately, predicting short-term movements is practically impossible, leading me to believe, once again, that short-sellers are playing with fire.

Caterpillar
Why are investors shorting Caterpillar?

• If any Dow component has made it way too easy on short-sellers, it's been Caterpillar, whose short interest actually rose a tad from the previous month. Caterpillar has significantly guided down its full-year revenue and EPS forecast three times within the past year, as mining visibility and orders have been negatively affected by weak commodity prices stemming from strong global stock markets and iffy commodity demand from China.

Is this short interest warranted?

• It's really tough to give pessimists a green light on such a global juggernaut like Caterpillar, but it's a bit worrisome when even Caterpillar's own management team is unsure when heavy manufacturing demand will improve. Data out of China earlier this week showing a weaker-than-expected manufacturing reading provides even more evidence that no one is certain where China's economy will head next. While select emerging markets could help Caterpillar's sales on a quarter-to-quarter basis, it'll need to see a rebound in China if it has any hope of shaking these pessimists off its back.

Verizon
Why are investors shorting Verizon?

• Sometimes you can do no wrong and still draw the ire of short-sellers, which is exactly what I believe is going on with telecom service provider Verizon. I would propose that the reason short interest rose fractionally month over- month is that Verizon is a slower-growth defensive name that is unlikely to be able to keep up with the markets' gains if it marches higher. Pessimists are counting on investors to sell out of defensive names like Verizon, potentially pushing its share price lower, in favor of purchasing higher growth, but riskier, investments.

Is this short interest warranted?

• There's always the possibility that increasing competition could be another factor why pessimists have latched on to Verizon, but even that story holds very little water, with Verizon Wireless possessing more 4G LTE-capable cities in the U.S. than its three major foes combined. It's obviously not going to stay that way forever, but it gives Verizon a big advantage in the interim when it comes to pricing power and attracting new enrollees on highly lucrative data plans. Verizon certainly paid through the nose as well to acquire a 100% working interest in Verizon Wireless, but I suspect we'll look back in 10 years and praise this as a smart move. All things considered, Verizon doesn't appear to be a company short-sellers should be focusing on.

Source: Jemimus, Flickr.

IBM
Why are investors shorting IBM?

• The easiest way to attract short-sellers is to be the laggard of the group, which is exactly what hardware and IT-infrastructure firm IBM was for the Dow in 2013 with a minus 1.5% return -- the only Dow component to finish the year lower. IBM's problems stem from weak overseas hardware spending, as well as tougher competition from the likes of Hewlett-Packard in the server market and Amazon.com in cloud-computing. IBM's most recent results simply weren't pretty, with the company reporting a 4% decline in revenue as high-margin service revenue dipped 3%, including negative foreign currency effects.

Is this short interest warranted?

• Like Intel, the answer is "yes" and "no," but it really depends on what you're trying to accomplish. For very short-minded traders, IBM could represent an intriguing opportunity because it's attempting to play catch-up in the cloud-computing space and lacks strong visibility in its overseas hardware markets. Over the long run, though, IBM has shown a knack for overcoming adversity and meetings its growth targets. In its third-quarter report we saw cloud revenue up 70% with Smarter Planet revenue up 20%. In other words, IBM's push into next-generation technology is working, which is a core reason Warren Buffett's Berkshire Hathaway is its top institutional shareholder. If IBM were to see ongoing weakness in 2014, I would certainly consider dipping my toes into the water with my own money.

AT&T
Why are investors shorting AT&T?

• Not to completely repeat myself, but telecom service provider AT&T has drawn a flock of pessimists for the same reasons as Verizon -- its inability to grow at a rapid rate and keep up with this robust stock market rally. Pessimists are expecting a secular rotation out of defensive names like AT&T to negatively affect its share price. And with Verizon in a superior position when it comes to 4G LTE-capable cities, pessimists expect AT&T to have to beef up its spending in order to catch up, meaning potentially weaker earnings over the next couple of quarters, or years.

Is this short interest warranted?

• While there is a possibility that higher R&D costs could slightly affect AT&T's bottom line, short-sellers seem to be making a big stink over nothing. In fact, in a remarkable move announced just yesterday morning, AT&T offered up to a $450 baited incentive for mobile users who switch from T-Mobile to AT&T and trade in a qualified smartphone. Consolidation has been the name of the game in the telecom sector, and AT&T is going to do what it can to ensure that it and Verizon remain the clear two dominant forces in mobile services in the United States. Short-sellers should probably look elsewhere for their next stock to bet against.