In less than four months, we’ll be breaking out a lot of candles and celebrating the 125th birthday for the Dow Jones Industrial Average (DJINDICES:^DJI). The market’s most-revered index has undergone more than 50 changes since its inception, and is today comprised of 30 brand-name, multinational companies.
Though all 30 Dow stocks have demonstrated that their operating models are time-tested, this hasn’t stopped short-sellers from making their mark. A short-seller makes money when a company’s share price declines (gains are capped at 100% since a company’s share price can’t go lower than $0). Conversely, losses for short-sellers are unlimited since there’s no upside ceiling on a company’s share price.
A quick screen of the Dow’s 30 components shows five whose short shares held relative to float is higher than 2%.
IBM: 2.95% of float held short
Throughout much of the past decade, being a pessimist on old-school tech stock IBM (NYSE:IBM) was a winning trade. The reason short-sellers have anointed IBM as the most short-old Dow stock has to do with company’s nearly precipitous revenue decline since 2012. IBM waited far too long to invest in the cloud and has seen sales for its legacy operations slowly dwindle.
If there is a positive for Big Blue, it’s that the company’s cloud operations are moving the needle in the right direction. Cloud revenue was up 10% during the fourth quarter, and it accounted for roughly 37% of total sales. Since cloud margins are so much juicier than all of IBM’s other operating segments, it should see more robust cash flow as cloud becomes a larger percentage of total sales.
IBM’s 2020 strategy made clear the company’s intention. Last year, it acquired seven companies that cater to the hybrid cloud or artificial intelligence. IBM is going to keep making acquisitions in the cloud space until the revenue needle begins moving in the right direction.
Salesforce.com: 2.74% of float held short
Short-sellers are also dog-piling one of the fastest-growing Dow stocks, customer relationship management (CRM) giant salesforce.com (NYSE:CRM). The best guess I can offer that would explain this pessimism is the collective expectation by investors that cloud stocks will pull back significantly after delivering triple-digit gains in 2020.
The thing is, salesforce is considerably more palatable from a valuation perspective than most other cloud stocks. It can be purchased for approximately 8 times forward-year sales, which is less than half the multiple you’ll find most software-as-a-service (SaaS) stocks trading at. Salesforce is also profitable on a recurring basis and on track to double its sales about every four years given its exceptional growth rate.
The bet against global CRM growth is an absolute head-scratcher. Cloud-based CRM applications have the potential to grow at a double-digit rate for many years to come, and they’re applicable to any consumer-facing business. Suffice it to say, I’m not expecting short-sellers to fare well.
Travelers: 2.39% of float held short
If salesforce is the most-exciting growth stock in the Dow, consider insurance company Travelers (NYSE:TRV) perhaps the most vanilla. Despite this boring business model, it hasn’t stopped the company from becoming the third most short-sold Dow stock.
My suspicion is that pessimists were honed in on the coronavirus recession and historically low interest rates weighing on Travelers. With so many people out of work, there was the possibility that commercial, property, and casualty insurance renewal rates would fall. Further, historically low lending rates have provided few avenues for insurers to generate income from their float (i.e., unused premium).
However, Travelers looks to have put skeptics in their place after reporting its fourth-quarter and full-year operating results for 2020 a little over a week ago. Net income for the full year jumped modestly amid the historic pandemic, with insurance renewal rates particularly strong across all three lines in the most recent quarter. Insurance might be boring, but the pricing power of insurers and the necessity for businesses to carry protection is undeniable.
Walgreens Boots Alliance: 2.11% of float held short
Like IBM, the pessimism surrounding pharmacy chain Walgreens Boots Alliance (NASDAQ:W(BA)) at least makes sense. Walgreens was hit by reduced foot traffic into its stores and clinics during the pandemic, and it’s been under pressure as big names like Amazon enter the online pharmacy space.
However, Walgreens isn’t just sitting on its laurels while these challenges take place. It’s already well into executing a multipoint turnaround plan. This strategy includes reducing $2 billion in annual operating expenses by 2022, but also spending aggressively on digitization. By focusing on its omnichannel presence, Walgreens can help boost its sluggish topline growth.
Even more exciting is the partnership between Walgreens and VillageMD. The two are going to deploy up to 700 full-service clinics on-site at select Walgreens’ locations in the United States. By offering a broader array of treatment options, Walgreens is hoping to attract repeat patients, as well as keep its higher-margin pharmacy segment busy. In short, betting against an already cheap Walgreens doesn’t look like a great idea.
Visa: 2.04% of float held short
Finally, short-sellers appear to have a fascination with betting against payment processor Visa (NYSE:V). Though it’s been a profitable trade for pessimists in recent weeks, betting against Visa for any longer period of time has been a poor decision.
The best guess I can offer as to why 2% of Visa’s shares are held short has to do with the coronavirus recession. Visa generates its revenue from processing fees. If the amount that businesses and consumers are charging on their credit cards declines, Visa’s revenue and profits will fall.
Unfortunately, the short thesis fails to take into account that Visa is purely a processor and not a lender. Avoiding the lending side of the equation means Visa has no direct liability to rising credit and loan delinquencies. In other words, it tends to rebound a lot faster than its processing peers, and it doesn’t have to set aside capital for losses when the U.S. or global economy turns south.
Visa is the undisputed credit card processing share leader in the U.S., and short-sellers are insane to bet against its dominance.