Surprisingly, These Are the Dow's 3 Least Liked Stocks

I'll admit that it's probably been seven years since I've said the following, but the Dow Jones Industrial Average (^DJI 0.63%) looks practically unstoppable right now. The iconic U.S. index that's composed of 30 of the biggest U.S.-based global giants has already logged eight all-time record closes in 2014, and investors are beginning to think that Dow 17,000 could be right around the corner. That's quite the feat considering we were looking at Dow 6,500 in March 2009.

Source: Andreas Poike, Flickr.

The basis of this rally has been an improvement in just about every major piece of economic data. The unemployment rate, for instance, has dipped from a high of 10% down to 6.3% as of Friday's U.S. Labor Department report. Historically low lending rates, which have remained under 5% for more than four years, have spurred lending, allowing business to expand and hire for a reasonably low cost and giving consumers the opportunity to refinance their homes and other debts at favorable levels. Other factors such as a rebound in the manufacturing sector and a surge in consumer confidence have given hope to investors that spending will continue to increase and productivity will slowly improve.

Yet this investing thesis won't fly with every investor. Skeptics out there will quickly point out that while the unemployment rate has dropped by 37% from its highs, the actual nonfarm labor force has grown only fractionally. Instead, a falling labor force participation rate has been the primary culprit for improved unemployment rates as baby boomers begin to retire and drop out of the workforce. Add onto this the fact that interest rates are expected to rise over the long run as QE3 is wound down and the Federal Reserve takes a less accommodative stance toward lending rates with the economy standing on its own two feet once again. In other words, there's just as many reasons to believe this rally could be near an end.

With these points in mind, I suggest we do what we do every month, which is take a closer look at the Dow's three most hated companies -- in essence, the three 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 three most hated stocks:

Source: S&P Capital IQ.

Intel
Why are investors shorting Intel?

• Despite a notable month-over-month decline in short interest, the bet against Intel remains largely unchanged for more than a year now. Because Intel's PC microprocessor piece of the pie is shrinking due to declining PC sales it's needed to spend heavily on researching and developing mobile processors for tablets and smartphones, as well as hardware to power big data center servers, just to catch up with its peers. This spending acts as a drag on its profits and can stymie its top-line growth as PC sales decline and mobile/data center sales ramp-up. With the markets roaring higher most skeptics believe few investors will want to hang onto the currently slow-growing Intel.

Source: Intel.

Is this short interest warranted?

• While there's certainly some logic to remaining skeptical on Intel given the lukewarm reception its processors have received in smartphones, and considering its slowly declining PC microprocessor sales, being a skeptic over the long-term on Intel probably won't work out for traders. Intel is already seeing strong in-roads in data center hardware which could make up around 30% of its revenue by the end of the decade. In addition, Intel's had some solid processing wins in tablets, which are still a rapidly growing market in the U.S. With Intel's share price up nearly 30% since September it's no longer the deal it once was, but even investors buying here are likely to be handsomely rewarded over the long run. Not to mention, intel's 3.3% yield is among the finest payouts in the tech sector.

AT&T
Why are investors shorting AT&T?

• There are two primary reasons why pessimists have continued to pile on AT&T in recent months. First, similar to Intel above, AT&T's growth rate greatly lags that of some of the markets' top performers. As a stalwart defense stock AT&T's telecom business delivers predictable cash flow and a very low degree of volatility. In a down market AT&T is a go-to investment, but in a market that shows no signs of slowing it's getting left in the dust by its competitors. Secondly, its pending merger with DirecTV (DTV +0.00%) has a lot of critics, especially considering that DirecTV's subscriber growth has been slowing. If this deal drags on or is ultimately overturned by the FCC it could wind up hitting AT&T's share price to the delight of short-sellers.

Source: AT&T.

Is this short interest warranted?

• A lot will depend on whether or not the DirecTV merger goes through, and if so whether or not the combination of the two companies is a long drawn-out affair. As it stands now AT&T is the antithesis of what a short-seller should be looking for in that it has a high yield of better than 5% which is sustainable, and it's a defensive low-beta stock meaning the often short-minded pessimists likely won't be making any quick money. But again, a lot is riding on what happens with its DirecTV buyout. Like Intel, I'd suggest that caution is warranted, but I wouldn't dare consider pulling the trigger against the household name-brand telecom company.

IBM
Why are investors shorting IBM?

• Have you noticed the trend here with the Dow's three least-liked stocks? Tech, tech, and more tech! IBM's troubles mirror those of Intel in that a decline in hardware sales and a softening of margins due to tougher competition, as well as a decisive move into the cloud for which it was unprepapred, has put IBM on the defensive and required the company to spend heavily on R&D in order to catch up to its peers. With revenue set to decline again in 2014 short-sellers are simply counting on investors cycling out of IBM and into riskier investments in order to take advantage of the markets' precipitous climb. Were this to happen, it's possible IBM shares could head even lower.

Source: IBM.

Is this short interest warranted?

• On one hand IBM's first-quarter report should merit a lot of skepticism with total sales down 4% including negative currency effects, and system and technology segment sales collapsing 23%. However, cloud revenue rose more than 50% with cloud-as-a-service run-rate revenue ballooning to $2.3 billion, or more than double last year's run-rate. What IBM lacks now it makes up for in its growth potential, cost-cutting efforts, and its ability to consistently meet its long-term financial goals. It also doesn't hurt that it's among Warren Buffett's largest holdings, and is a free cash flow cow. While there could be very short-term pockets of weakness in IBM, this is a business that I expect to increase in value over the long run.