The Dow's 5 Most Hated Stocks

The Dow Jones Industrial Average (^DJI +0.48%) may not be knocking off new all-time highs on a daily basis like the broader market S&P 500, but it is once again with striking distance of a new high as it's rebounded ferociously off its beginning-of-the-year swoon.

Helping the Dow move decisively higher has been a steady recovery in the U.S. economy, aided by a double-digit rise in home prices, a precipitous fall in the unemployment rate, improving worker productivity, and the continuation of historically low lending rates.

But are things really as they appear?

Two months ago we looked at three variables that may be inflating how strong the U.S. economy actually looks. The first is the labor participation rate, which has been falling consistently for the past 14 years. Some of this drop is expected as baby boomers hit their retirement age and others go back to school, but a growing concern is that some people have simply given up on finding work. Comparing the current number of employed workers with those in mid-2008, you'd see that job creation is basically flat.

Second, the Federal Reserve's economic stimulus, QE3, has been a boost for the housing and banking sector, but has spoiled the U.S. consumer by keeping rates too low for too long, By artificially keeping rates low and reducing this sense of urgency, consumers have drastically cut back on loan originations anytime lending rates tick up in the slightest.

Finally, a combination of stock buybacks and cost-cutting has helped push corporate earnings higher, but it's also masking what has generally been weak organic growth.

With these points 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.

Caterpillar
Why are investors shorting Caterpillar?

• The bet against heavy-duty machinery manufacturer Caterpillar has grown dramatically within just the past month, rising from 3.46% last month to 5.96% this month. The reason for the recent run higher was its sizable earnings beat in the fourth quarter, which was a complete surprise after Caterpillar had lowered its earnings guidance on three separate occasions last year. Short-sellers are betting that this past quarter, which was aided primarily by cost-cutting, was nothing more than a fluke, and that weak mining demand will continue to weigh on Caterpillar's share price.

Is this short interest warranted?

• With Caterpillar's management remaining cautious in 2013 and not exactly knowing when this protracted downtrend in heavy-duty machinery would end, I'd suggest that a high level of skepticism could be warranted, at least in the interim. Over the long run, Caterpillar is well positioned globally and has incredible pricing and brand power, which should translate into decades of growth potential, especially in emerging markets. Over the near term, though, stagnant commodity prices could put a cap on any upside in Caterpillar's share price and play right into the hands of short-sellers.

Patrick Gelsinger, Intel Sr. VP, Source: Intel.

Intel
Why are investors shorting Intel?

• The bet against Intel hasn't changed in more than a year now, with pessimists counting on Intel's PC processing business to slowly shrink, and for the company to have to spend heavily on research and development to play catch-up with regard to mobile processing and the cloud. The end result has been stagnant top- and bottom-line growth for Intel, which short-sellers suspect will weigh on Intel's share price.

Is this short interest warranted?

• Pessimists do have a point about continued PC declines, with research firm IDC upping its estimate this past week from an expected 3.8% decline in 2014 to 6.1%. Furthermore, IDC anticipates that PC sales will decline through 2018.While that's not good news for Intel, what is good news is that it'll still be able to generate significant cash flow from its dominant position as the processing king of PCs to fund its mobile and cloud-based R&D. Intel has already shown small snippets of success in penetrating the mobile tablet market and should be a major player in cloud-based hardware by the end of the decade. I believe you'd be doing yourself a disservice by writing off Intel here.

AT&T
Why are investors shorting AT&T?

• The reason short-sellers have piled into AT&T has nothing to do with poor results. It merely has to do with the risk-on investing approach we're witnessing throughout the market that has traders cycling out of traditionally defensive names like AT&T, which grows at very slow but steady rate, and instead focusing on seeking out riskier but higher-growth investments. In addition, relative to Verizon, AT&T is trailing in 4G LTE-capable cities, meaning it'll have to spend bountifully if it hopes to catch its main rival. 4G LTE is a strong lure in the U.S. to gaining new smartphone subscribers.

Is this short interest warranted?

• Somehow this short trade has indeed worked for pessimists over the past year, but I doubt it'll work over the long run. Sectorwide consolidation should help tighten AT&T's costs (AT&T is purchasing Leap Wireless), and mobile devices have practically become necessity products for much of today's consumers. What this means for AT&T is steady cash flow, a healthy dividend that's currently yielding 5.8%, and few reasons to bet against the company.

Verizon
Why are investors shorting Verizon?

• Although telecom giants Verizon and AT&T switched spots this month, with AT&T leapfrogging Verizon in a bad way, the story is almost exactly the same for both. Like AT&T, Verizon bears a high number of short-sellers because it's generally a slower-growth business model that simply won't be able to keep up with the double-digit growth traders are witnessing in the networking and cloud-tech space. As investors cycle out of these defensive names, they tend to slowly tick lower.

Is this short interest warranted?

• Let me be clear that I don't think betting against AT&T or Verizon is a smart idea, but with the recent acquisition of its remaining unowned interest in Verizon Wireless from Vodafone, coupled with its sizable lead in rolling out 4G LTE-capable networks across the U.S., Verizon makes even less sense than AT&T to bet against. Verizon is paying out a premium 4.4% yield, and at 12 times forward earnings it looks ripe as a possible buy, if you ask me.

IBM
Why are investors shorting IBM?

• Are you noticing the major tech bias on this list of the Dow's most hated companies? No. 2 through No. 5 are all tech or telecom based! IBM finds its way onto this list for many similar reasons as Intel. IBM has seen its hardware division get whacked by weakening demand, and, like Intel, has had to beef up its R&D spending to develop new cloud-based products. Pessimists believes that Big Blue may simply have fallen too far behind not to see its EPS erode in the near-term.

Is this short interest warranted?

• On the surface, IBM looks like a company that should be avoided as it transitions to a number of new products. However, with the backing of Warren Buffett's Berkshire Hathaway as a major shareholder, as well as its incredibly strong cash flow, I'd suggest that short-sellers would probably be wise to lock in their gains now and keep their distance. With its forward P/E of just 9, I've even added IBM to my personal watchlist as a possible buy candidate.