3 Must-Short Dow Stocks For 2013

Includes: CAT, HPQ, UNH
by: Larry Meyers

My Dow shorts for last year weren't as stellar performers as my buys. I felt McDonald's (NYSE:MCD) was a great company but vastly overpriced last January 6 when the stock was at $100.60. It ended 2012 at $88.21, for a return of 12.3%. Verizon (NYSE:VZ) surprised me. I suggested shorting at $38.33 because competition in the telecom space just seemed too fierce for the company to make any real headway. It ended the year at $43.27, so you would've lost 12.8% on that one. My mistake there was that Verizon paid a very healthy divided and generated great cash flow, so fixed income investors love the stock. But the real mistake came with Bank of America (NYSE:BAC), which I suggested shorting at $6.18, and ended at $11.61. Ouch. My mistake here was not realizing BofA services 80% of the country's mortgages, collecting servicing fees without having risk. The bank is financially rock solid.

Then again, shorting any stock in the Dow last year wasn't easy. Only 5 of the 30 stocks actually ended in negative territory, and I nailed one of them.

So are there three stocks worth shorting in the Dow this year? Yes. Am I sticking my neck out? Maybe, but I don't think so. With the economy stumbling along at 1-2% growth, the stocks to short are those that are 1) run poorly, 2) unable to keep up with competition, 3) targeted for increased regulation, or 4) aren't offering a large enough dividend.

In the case of Hewlett-Packard (NYSE:HPQ), it is becoming obsolete. I'm not saying that cloud computing will take over in 2013, but the desktop computer business is now a sunset industry. Besides the cloud, it's tablets and smartphones. Hewlett doesn't have a smartphone and it would have big-time competition even if it did. Printers are great, but their margins aren't that sexy because - again - competition is fierce. Cisco Systems (NASDAQ:CSCO) has the edge on software-defined networking, so the company's progress there will be limited. The company just wrote off $8.8 billion for a bad acquisition, sits on $9 billion in cash against over $24 billion in debt. The good news is that the company generates some $5.5 billion in free cash flow each year. Still, that won't be enough to entice buyers. I say short it here, even though it was down 44% last year.

I think health insurers are in trouble long term. So although I like that UnitedHealth (NYSE:UNH) has a big chunk of the Medicare market and that it is diversifying its base by doing more in the health services business, I do not like the long term cloudiness of the sector. Its costs are going to increase under Obamacare. Financially, the company is solid, with its $12 billion in debt almost entire offset by its cash position. It generates about $3.8 billion in free cash flow. However, it only pays a 1.6% dividend, and I believe with bonds yielding next to nothing, investors will look for higher yields in sectors with greater visibility. Short UnitedHealth, possibly for more than this year.

The economy is growing, but slowly, so I don't expect much out of the heavy-lifting sector. Caterpillar (NYSE:CAT) is expected to see a drop in earnings from $9.13 per share to $8.70 per share in 2013 on flat revenue. It's a company that draws on a lot of debt to get its business to do what it does, but that $26.5 billion in debt comes at a very low price, so there's no concern about the company in a macro sense. However, free cash flow was hard to come by in 2012 and that will likely continue. In fact, the company was FCF negative to the tune of $300 million. One hopes this is not a long-term issue. I don't expect much for Caterpillar this year, and with only a 2.3% yield, I think investors will pull their money out and look elsewhere.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.