Short sellers get ideas from many sources. Some of the best ideas come from the most obvious of places - Barron's, WSJ, Forbes, etc. Short interest and stock float are important. A short seller should make sure the short interest is not so high that a short squeeze can increase the risk relative to return.
Franchises have extensive potential for financial stumbles; and once one franchise is analyzed, a group of them can be easily perused. A short seller should look for types of business that eat money - financial services and real estate - or companies with complex financial statements and blind pools of investments - the financial sector is another solid choice in this category. Once a company is targeted it should be analyzed with skepticism and curiosity every time a new financial document is published.
(1) The Pessimist's Guide to Financial Statements
The financial statements are always the first step for any serious student of stocks. Short sellers attempt to discover what is behind the numbers, what drives the company, what the business prognosis is.
Quality control - The first look at the financials is with the intent of breaking teh company into tiny pieces and checking to see if all those pieces are real. The most useful part of the financials will be the footnotes. The other consistent keys are what is not there and what cannot be understood. Start by looking for bogus assets. Then test accounts receivable and inventories looking at growth versus previous years and comparing growth to growth in sales and CGS. If the receivables growth is substantially greater than the growth in revenue, problems with earnings are likely. Growth in inventory vs growth in CGS is the single most reliable indicator that a manufacturer or retailer will stumble. A frequent area of abuse is deferred charges. Examples of deferred charges are prepaid advertising and deferred commissions or sales charges. Another category worthy of jaundice is goodwill and other intangible costs. Capitalizing routine expenses is another clue that a company is manipulating earnings. Accumulated depreciation is a sleeper balance sheet line that nobody watches much. If accumulated depreciation drops when gross PPE rises, the company might have changed the average life assumption and run the reversal through the income statement or might have simply reduced the depreciation expense in subsequent quarters. Look for off balance sheet liabilities, debt guarantees or recourse factored receivables. Make a subjective decision on what percentage of the business is stable and repeatable. Give it the buzz word test. Watch for auditor turnover - it is the one signal that is truly indicative of trouble.
(2) In Search of Greed and Sleaze
Form 4 - insiders purchases or sales.
Proxies - one of the best data sources for inurement and greed.
WRT salaries - compare salaries + bonuses to net income. Look at cash compensation relative to company earnings. Does the company pay a % of pretax profits to the primary officers in the form of a bonus? Are they paid a % of revenues? Does the company pay a bonus for taxes on options? Terms of retirement contracts? Unusual severance pay contracts? Arms length transactions??? Is the board a bunch of rubber stamps?
(3) The Bigger Puzzle
The research segment starts in the library, whereas the store check segment ends up watching the marketplace.
(4) Who Owns It?
High institutional ownership and high Wall St coverage can make for a quick collapse if something unexpected happens.
(5) Check The Water Temperature
Accumulate brokerage reports to provide the company think and Wall St attitude. Use analysts for indications of Street-think and as conduits of management information.
(6) Pay Attention
Keep paying attention. The date of the earnings release is also statistically relevant. The later they are, the worse the numbers. Keep watching - once a potential target, always a potential target. Do not cover just because of price movements; wait until resolution of the scenario. Short selling can be much like a cat waiting outside a mouse hole - the level of persistence, patience, and attentiveness is not for everyone, especially over sustained periods of time.
Recap
Wall St ices the inefficient cake with compulsive conformity. Everyone gets on the bandwagon and stays until the evidence is too compelling, then they all fall off with a jolt.
Do not genuflect in front of a business, an executive or an analyst. Keep your distance and your objectivity. The stock market is about people disagreeing over stock prices.
A short seller is a skeptic with a constructive, optimistic bent.
The rule of thumb when you study a proxy is that if you have to read it three times, you have struck pay dirt.
Showing posts with label The Art of Short Selling. Show all posts
Showing posts with label The Art of Short Selling. Show all posts
Wednesday, July 2, 2014
The Art of Short Selling - Criticisms of Short Selling
Short sales established an inflated supply and cause price declines.
The laws of supply and demand cannot be contravened by laws artificially restricting marketing methods. Or, in the words of Bernard Baruch, "No law can protect a man from his own errors. The main reason why money is lost in stock speculations is not because Wall St is dishonest, but because so many people persist in thinking that you can make money without working for it and that the stock exchange is the place where this miracle can be performed."
The laws of supply and demand cannot be contravened by laws artificially restricting marketing methods. Or, in the words of Bernard Baruch, "No law can protect a man from his own errors. The main reason why money is lost in stock speculations is not because Wall St is dishonest, but because so many people persist in thinking that you can make money without working for it and that the stock exchange is the place where this miracle can be performed."
The Art of Short Selling - Shortcomings
The short sellers post price run-up exercise is to determine where the clues failed, why the price levitated, and why a normally accurate trail sign was misleading.
Three Short Sins: Sloth, Pride, Timing
Sloth
The first and biggest reason for failure in stock selection on either the short side of the long side is too little work. Usually, sloth is prompted by shorting someone else's idea.
Pride
Hubris is manifest in two primary analytical errors: (1) the sudden use of rigid formulas, and (2) the short sale of good companies.
Shorting a good company is always risky. A good company is a company with smart management who pay attention to business trends and customers and who have financial statements reflecting that unlikely blend. A valuation short is no different than a market bet.
Timing
The timing problem is the single biggest argument against individuals short selling - it throws off the risk/return relationships and suggests that individuals should use the discipline for selling or not owning stocks rather than for short selling. Investor ebullience can keep a stock price up for years in spite of no earnings, even no product. The second reason for the timing problem is the ability of investment bankers to sell another round of financing despite a seriously flawed corporate business plan. Continued flows of financing can keep a dead company on a respirator for years. In some instances, the lag time between the discovery of a fatal flaw and the demise of the company results in a change in the macroenvironment that bails out the troubled short sale candidate. Shorts all too often fail to realize how long debt takes to sink a company when the business environment is good. Almost every short position lasts too long for sellers.
One way to tweak timing is to wait until a stock cracks to short initially, after the first drop when the earnings and price momentum have slowed.
Commodities
It is easier to find fundamental balance sheet flaws than to trade grain prices. Make sure any short bet is on the company and not the commodity.
Tech Stocks
Tech inventories rise when a new product is in the works. Insiders own volumes of stock and sell often and without apparent regard for company condition. Margins can contract and expand with product cycles and the pricing curve.
Squeezes
The float of a stock is of paramount importance for a short position. Short slamming tactics do not work well for a company with a large float and a heavy Wall St following.
Complexity
Many short sellers fall in love with their own analysis, particularly if it is clever or extremely complex.
Lastly
The mistake is always shorting the company that's not that bad. The analyst has to be convinced that the core business will be overwhelmed by the problem and not just a hiccup. You can hide disgusting accounting practices with growth for a very long time.
Three Short Sins: Sloth, Pride, Timing
Sloth
The first and biggest reason for failure in stock selection on either the short side of the long side is too little work. Usually, sloth is prompted by shorting someone else's idea.
Pride
Hubris is manifest in two primary analytical errors: (1) the sudden use of rigid formulas, and (2) the short sale of good companies.
Shorting a good company is always risky. A good company is a company with smart management who pay attention to business trends and customers and who have financial statements reflecting that unlikely blend. A valuation short is no different than a market bet.
Timing
The timing problem is the single biggest argument against individuals short selling - it throws off the risk/return relationships and suggests that individuals should use the discipline for selling or not owning stocks rather than for short selling. Investor ebullience can keep a stock price up for years in spite of no earnings, even no product. The second reason for the timing problem is the ability of investment bankers to sell another round of financing despite a seriously flawed corporate business plan. Continued flows of financing can keep a dead company on a respirator for years. In some instances, the lag time between the discovery of a fatal flaw and the demise of the company results in a change in the macroenvironment that bails out the troubled short sale candidate. Shorts all too often fail to realize how long debt takes to sink a company when the business environment is good. Almost every short position lasts too long for sellers.
One way to tweak timing is to wait until a stock cracks to short initially, after the first drop when the earnings and price momentum have slowed.
Commodities
It is easier to find fundamental balance sheet flaws than to trade grain prices. Make sure any short bet is on the company and not the commodity.
Tech Stocks
Tech inventories rise when a new product is in the works. Insiders own volumes of stock and sell often and without apparent regard for company condition. Margins can contract and expand with product cycles and the pricing curve.
Squeezes
The float of a stock is of paramount importance for a short position. Short slamming tactics do not work well for a company with a large float and a heavy Wall St following.
Complexity
Many short sellers fall in love with their own analysis, particularly if it is clever or extremely complex.
Lastly
The mistake is always shorting the company that's not that bad. The analyst has to be convinced that the core business will be overwhelmed by the problem and not just a hiccup. You can hide disgusting accounting practices with growth for a very long time.
Tuesday, July 1, 2014
The Art of Short Selling - Industry Obsolescence: Theme Stocks
Massive industry change can be triggered by macroeconomic events, by a specific product revolution, or by the death of a fad.
Wall St is much quicker to hype a new fad than to discard the old.
1980s Texas taught investors that when a region and its economy are built on growth, a slowing rate of change in the growth engine can pull the whole structure to the ground.
Banks are classic short candidates because the lending cycle is only as long as the credit experience of the current crop of bankers.
Betting on a real estate downturn means short the companies with big real estate exposure. Real estate always takes a while to work out because it is not marked to market every day.
How much damage can a wretched real estate environment do to a bank? The real estate pros knew that when it came, it lasted - three to four year minimum to clear out the overhang, with banks trading as low as 40% of book.
They knew that buying a bank stock or an S&L stock was like buying a blind pool. Buyers never knew what they had, so the macroenvironment had better be right.
When no one cares anymore, it is usually time to buy long or at least cover shorts.
Banks with their arcane and specialized terminology, are boring, to analyze, much like insurance companies. As a group, banks are perceived as sacred, inviolate, protected by the govt and the many insurance programs. They are in fact highly leveraged corporations. When equity is only 5% of assets, it does not take much to nibble through the base. So banks can be profitable and predictable on both sides, particularly if shareholders or stock sellers count cranes in their own backyards to determine how frenetic the pace of real estate expansion really is relative to the perceived economic growth in town.
Wall St is much quicker to hype a new fad than to discard the old.
1980s Texas taught investors that when a region and its economy are built on growth, a slowing rate of change in the growth engine can pull the whole structure to the ground.
Banks are classic short candidates because the lending cycle is only as long as the credit experience of the current crop of bankers.
Betting on a real estate downturn means short the companies with big real estate exposure. Real estate always takes a while to work out because it is not marked to market every day.
How much damage can a wretched real estate environment do to a bank? The real estate pros knew that when it came, it lasted - three to four year minimum to clear out the overhang, with banks trading as low as 40% of book.
They knew that buying a bank stock or an S&L stock was like buying a blind pool. Buyers never knew what they had, so the macroenvironment had better be right.
When no one cares anymore, it is usually time to buy long or at least cover shorts.
Banks with their arcane and specialized terminology, are boring, to analyze, much like insurance companies. As a group, banks are perceived as sacred, inviolate, protected by the govt and the many insurance programs. They are in fact highly leveraged corporations. When equity is only 5% of assets, it does not take much to nibble through the base. So banks can be profitable and predictable on both sides, particularly if shareholders or stock sellers count cranes in their own backyards to determine how frenetic the pace of real estate expansion really is relative to the perceived economic growth in town.
The Art of Short Selling - If You Can't Fix It, Sell It
Three categories of opportunity appear in a bull market (1) the restructured and heavily indebted company close to a stumble, (2) the "for sale" but not sold company, and (3) the company with deteriorating earnings that attempts to create the appearance of health with the sale of assets.
Assets are hard to value in a greater fool environment. Before a stock is shorted, the maximum buy-out value must be lower than the stock price.
Parkinson's Law of Short Selling: the stock price expands to fill the available short capacity and last iota of patience, particularly when it is a "no brainer."
From the Kay Jewelers example, the shorts concluded from the buy-out announcement frenzy that short speculation on "for sale" candidates was a less risky business than risk arbitrage - particularly if you could stand the news announcements and upward lurches.
Assets are hard to value in a greater fool environment. Before a stock is shorted, the maximum buy-out value must be lower than the stock price.
Parkinson's Law of Short Selling: the stock price expands to fill the available short capacity and last iota of patience, particularly when it is a "no brainer."
From the Kay Jewelers example, the shorts concluded from the buy-out announcement frenzy that short speculation on "for sale" candidates was a less risky business than risk arbitrage - particularly if you could stand the news announcements and upward lurches.
The Art of Short Selling - Money Suckers: Coining Money To Live
Some companies require great gulps of capital to stay alive, even during periods of economic expansion. When operations fail to prime the pump of free cash flow, financial markets irrigate the basic business. To fund a company that goes to the markets routinely, the debt or equity buyer must assume one of two things: that the company will either eventually earn enough money to pay back the obligation or will make a reasonable return on equity or that the assets on the balance sheet will appreciate enough so that the sale will cover the outstanding obligation.
When the market appetite for new debt and equity disappears, so does the company.
When a fundamental change occurs in the business environment, there are two strategies to follow for the short seller: short the marginal company or short the institutional favorite. The institutional favorite is the quality company with good growth, pretty financials and a large number of institutional investors. Insto favorites crash more quickly than marginal companies because the instos all head to the exit at the same time. The marginal company has shaky financials, bad management, and a history of aggressive but often poorly executed business strategies. Problems develop more rapidly when no support exists. The stockholder base is less sophisticated. They are slower to sell, they pay less attention, or even worse they are comprised of friends and family.
Prepaid acquisition costs are costs that the company decided to defer expensing until later.
The most important lesson from Integrated, one that should have been obvious, was that banks and other short term lenders control the destiny of a company that has negative cash flow.
Short maxim: wait to short until reality can be proved, ie. wait until actual earnings come in less than expected.
When the bulls start talking about takeovers - always a good sign for the bears.
The most prevalent mistake of short sellers is that they are often shortsighted about the duration of hope for a new industry and for concomitant stock price decreases.
When the market appetite for new debt and equity disappears, so does the company.
When a fundamental change occurs in the business environment, there are two strategies to follow for the short seller: short the marginal company or short the institutional favorite. The institutional favorite is the quality company with good growth, pretty financials and a large number of institutional investors. Insto favorites crash more quickly than marginal companies because the instos all head to the exit at the same time. The marginal company has shaky financials, bad management, and a history of aggressive but often poorly executed business strategies. Problems develop more rapidly when no support exists. The stockholder base is less sophisticated. They are slower to sell, they pay less attention, or even worse they are comprised of friends and family.
Prepaid acquisition costs are costs that the company decided to defer expensing until later.
The most important lesson from Integrated, one that should have been obvious, was that banks and other short term lenders control the destiny of a company that has negative cash flow.
Short maxim: wait to short until reality can be proved, ie. wait until actual earnings come in less than expected.
When the bulls start talking about takeovers - always a good sign for the bears.
The most prevalent mistake of short sellers is that they are often shortsighted about the duration of hope for a new industry and for concomitant stock price decreases.
The Art of Short Selling - If You Can't Read It, Short It
Most companies write reports that are comprehensible to a person with a fair knowledge of accounting terminology. Some companies write reports that are impossible to follow, even for accounting experts. Experience suggests that if you cannot understand a report, officers are hiding something worse than you expect. It is almost an iceberg phenomena: If you find five or six serious questions in financial statements, you can be sure that there are many more that you cannot see. If a call to the company for explanation receives a garbled response that sounds suspiciously like the company official is speaking in tongues, you have got a live one.
The simplest form of financial obfuscation is detected by tracking the growth in receivables versus the growth in sales. Outsized growth leads the analyst to search out policies on booking revenues and collecting cash.
Any asset that does not have a ready market value is fair game for asset shuffling. The following are the most important points about insurance company financial statements:
The proper valuation of assets and liabilities is most important to the accuracy of the surplus total. Surplus provides the cushion for surprises and the funds for expansion. It is the heart of an insurance company. It also determines how much an owner can take out and whether the regulators take over.
Insurance companies have a lot of leeway on the carrying value of securities, particularly when the assets do not have a public market value. As a critical bystander, all you have to do is cast doubt on the quality of some of those assets to avoid owning the parent stock. If you question a significant number of assets relative to surplus, short the parent.
The simplest form of financial obfuscation is detected by tracking the growth in receivables versus the growth in sales. Outsized growth leads the analyst to search out policies on booking revenues and collecting cash.
Any asset that does not have a ready market value is fair game for asset shuffling. The following are the most important points about insurance company financial statements:
- All insurance companies are required to file annual financial statements with the state insurance department (filed in March).
- These statements require different accounting practices ("statutory accounting") so they don't match GAAP. The driving force of statutory accounting is liquidity. The spirit of the rule is the determination of solvency or of claims paying ability.
- All this fits together in one number called surplus (similar to net income).
The proper valuation of assets and liabilities is most important to the accuracy of the surplus total. Surplus provides the cushion for surprises and the funds for expansion. It is the heart of an insurance company. It also determines how much an owner can take out and whether the regulators take over.
Insurance companies have a lot of leeway on the carrying value of securities, particularly when the assets do not have a public market value. As a critical bystander, all you have to do is cast doubt on the quality of some of those assets to avoid owning the parent stock. If you question a significant number of assets relative to surplus, short the parent.
The Art of Short Selling - High Multiple Growth Stocks, Part 2: High Returns, Faltering Growth
The very backbone of a bull market is growth - new products, new sales, new technology.
There is almost always a bell ringing on the growth stocks that have one product. Shorts get killed trusting their intuition and common sense. Longs get killed with their belief that the company can always expand to one more market.
Two relevant concepts that define the shorts analytical task are pipeline fill and sustainable growth. Pipeline fill gives the revenue curve its shape. Sustainable growth rate sets the financing needs for that curve.
Cott Corp - going against Coke and Pepsi. Most corporate managers reproduce the errors of the past with remarkably regular frequency and inspire their corporate culture with the same consistence of mismanagement.
Pipeline fill refers to the process of filling the distribution channels' inventories - think drug companies getting out a new product. At some point the pipeline is full - every store has a shelf of product - and the growth rate is purely what the consumer consumes.
Cott paid sr employee salaries with stock and capitalized the expense as goodwill on the balance sheet. Watch when an analyst goes to work for a firm they covered. Top tick.
The Snapple story was a great lesson for growth stock players and short sellers alike. Store checks and valuation be damned, inventories are key in a one product company rolling out in a new era industry. If they build up, it is almost always because the product is not selling as planned.
Media Vision and Creative Technology - operate in an industry/sector that is characterized by short product life cycles and rapid change.
The bigger point on cash appetite in a growth company is a concept called sustainable growth rate. Sustainable growth rate says that a company can grow at the rate of return on equity times the retention rate without going to the capital markets. Growth companies with low ROE have to go to the market early and often and, if the prospects for eager buyers decline due to market conditions or failing financials, they have big trouble.
Growth is a good stock to own and a great stock to short if you can time both sides of the pyramid.
There is almost always a bell ringing on the growth stocks that have one product. Shorts get killed trusting their intuition and common sense. Longs get killed with their belief that the company can always expand to one more market.
Two relevant concepts that define the shorts analytical task are pipeline fill and sustainable growth. Pipeline fill gives the revenue curve its shape. Sustainable growth rate sets the financing needs for that curve.
Cott Corp - going against Coke and Pepsi. Most corporate managers reproduce the errors of the past with remarkably regular frequency and inspire their corporate culture with the same consistence of mismanagement.
Pipeline fill refers to the process of filling the distribution channels' inventories - think drug companies getting out a new product. At some point the pipeline is full - every store has a shelf of product - and the growth rate is purely what the consumer consumes.
Cott paid sr employee salaries with stock and capitalized the expense as goodwill on the balance sheet. Watch when an analyst goes to work for a firm they covered. Top tick.
The Snapple story was a great lesson for growth stock players and short sellers alike. Store checks and valuation be damned, inventories are key in a one product company rolling out in a new era industry. If they build up, it is almost always because the product is not selling as planned.
Media Vision and Creative Technology - operate in an industry/sector that is characterized by short product life cycles and rapid change.
The bigger point on cash appetite in a growth company is a concept called sustainable growth rate. Sustainable growth rate says that a company can grow at the rate of return on equity times the retention rate without going to the capital markets. Growth companies with low ROE have to go to the market early and often and, if the prospects for eager buyers decline due to market conditions or failing financials, they have big trouble.
Growth is a good stock to own and a great stock to short if you can time both sides of the pyramid.
The Art of Short Selling - High Multiple Growth Stocks, Part 1: High Risk, Low Return
Bubble stocks are the purest and easiest form of short selling.
The simplest form comes from a company with a fad product that is perceived to have a long life. The next level of financial complexity is a concept or theme stock, from companies that sell a product or service to fill a newly perceived need.
Wall St awards preliminary kudos to companies just for trying or just for hiring the right investment banker or public relations agent. And that is what makes shorting concept stocks chilling, palm sweating, white knuckle hard work.
Questions to ask about concept stocks: does it work? how soon will it run out of money?
Shorts almost always judge correctly if the business is dying. On the timing of the demise, they are seldom right. Someone is usually available to buy stock, loan money, offer short term bank debt long after the company's financials are in nearly terminal condition.
Add two years to a short's best projection, and you might only have a couple more years to wait.
Grizzled analyst wisdom says sell the stock of a company building a new headquarters that is owned, not leased. It is a top of the earnings cycle clue.
Cute tickers for fad/concept companies is another tell.
The patience required to track the trail of failure is a critical skill for short sellers avoiding the wrong stock or the wrong time in a growth company's price trajectory.
Cockroach theory: there is no usually just one bad quarter. Expect more to follow.
Concept stocks: cabbage patch kids, Coleco (home computers), Scoreboard (baseball cards), J. Bildner (yuppie/upscale grocery stores), Jiffy Lube (quick oil change franchises).
The simplest form comes from a company with a fad product that is perceived to have a long life. The next level of financial complexity is a concept or theme stock, from companies that sell a product or service to fill a newly perceived need.
Wall St awards preliminary kudos to companies just for trying or just for hiring the right investment banker or public relations agent. And that is what makes shorting concept stocks chilling, palm sweating, white knuckle hard work.
Questions to ask about concept stocks: does it work? how soon will it run out of money?
Shorts almost always judge correctly if the business is dying. On the timing of the demise, they are seldom right. Someone is usually available to buy stock, loan money, offer short term bank debt long after the company's financials are in nearly terminal condition.
Add two years to a short's best projection, and you might only have a couple more years to wait.
Grizzled analyst wisdom says sell the stock of a company building a new headquarters that is owned, not leased. It is a top of the earnings cycle clue.
Cute tickers for fad/concept companies is another tell.
The patience required to track the trail of failure is a critical skill for short sellers avoiding the wrong stock or the wrong time in a growth company's price trajectory.
Cockroach theory: there is no usually just one bad quarter. Expect more to follow.
Concept stocks: cabbage patch kids, Coleco (home computers), Scoreboard (baseball cards), J. Bildner (yuppie/upscale grocery stores), Jiffy Lube (quick oil change franchises).
Monday, May 12, 2014
The Art of Short Selling - Bubble Stocks
A perfect short sell candidate is a stock with a large float to allow ease of borrowing and no buy-ins (forced buyback), a high stock price for maximum return, and no business or assets to keep the risk nominal and the investment horizon short term. A perfect short can cause terrible losses.
The single most important section in a prospectus is the risk factor section called "Investment Considerations." The company always tells you why it will fail.
The single most important section in a prospectus is the risk factor section called "Investment Considerations." The company always tells you why it will fail.
Wednesday, May 7, 2014
The Art of Short Selling - Short Sellers
Robert Wilson (profiled by John Train in The Money Masters) is the acknowledged grandfather of the short selling hedge fund managers.
Julian Robertson used a fundamental approach based on prodigious research and a long term horizon. Valuation bets on price alone make bad short sales. There must be either a fundamental change in the outlook or a major misconception by the stock buying public.
Alex Porter (Porter, Felleman) - the trick is to be short the stocks you can stay short without pain or expense. He likes shorts where mgmt doesn't own much stock, management is not realistic or forthright, and where the company has a fatal balance sheet flaw.
Joe DiMenna (Zweig Funds) - Short frauds, earnings disappointments, hyped stocks, industry themes where macro forces are negative and deteriorating balance sheets. Try to determine a catalyst. Don't short stocks with strong relative strength and earnings momentum.
Short sellers tend to be odd people. Most are ambitious, driven, antisocial and singleminded. They are contrarian by nature and like to win against the odds. They often have a chip on their shoulder.
The Feshbachs looked for terminal shorts: (1) stock price overvalued at least by 2x's reasonable valuation, (2) A fundamental problem at the company, (3) A weak financial condition, (4) Weak or crooked management. They perceived themselves as hype detectors. To sell short you have to be certain that you see an important factor that other people do not see. You look for something that is obviously misperceived, obviously important, and obviously detrimental. The most important charater trait of a short seller is the ability to remain analytical when other people panic.
For McBear management is rarely the target, unless there is fraud. It is generally Wall St that has engineered the ascent of the stock.
Chanos' specialty is solving complex financial puzzles. He likes to short stocks with secular problems where he can make a "reasonably strong argument, based on the valuaton of the business, that the equity value of the enterprise is $0." Chanos does not visit companies. Likes to focus on return on invested capital as a key financial indicator. When the accounting gets murky people tend to shy away from rigorous analysis and rely on management and just take earnings per share at face value. Therein lies the opportunity.
Julian Robertson used a fundamental approach based on prodigious research and a long term horizon. Valuation bets on price alone make bad short sales. There must be either a fundamental change in the outlook or a major misconception by the stock buying public.
Alex Porter (Porter, Felleman) - the trick is to be short the stocks you can stay short without pain or expense. He likes shorts where mgmt doesn't own much stock, management is not realistic or forthright, and where the company has a fatal balance sheet flaw.
Joe DiMenna (Zweig Funds) - Short frauds, earnings disappointments, hyped stocks, industry themes where macro forces are negative and deteriorating balance sheets. Try to determine a catalyst. Don't short stocks with strong relative strength and earnings momentum.
Short sellers tend to be odd people. Most are ambitious, driven, antisocial and singleminded. They are contrarian by nature and like to win against the odds. They often have a chip on their shoulder.
The Feshbachs looked for terminal shorts: (1) stock price overvalued at least by 2x's reasonable valuation, (2) A fundamental problem at the company, (3) A weak financial condition, (4) Weak or crooked management. They perceived themselves as hype detectors. To sell short you have to be certain that you see an important factor that other people do not see. You look for something that is obviously misperceived, obviously important, and obviously detrimental. The most important charater trait of a short seller is the ability to remain analytical when other people panic.
For McBear management is rarely the target, unless there is fraud. It is generally Wall St that has engineered the ascent of the stock.
Chanos' specialty is solving complex financial puzzles. He likes to short stocks with secular problems where he can make a "reasonably strong argument, based on the valuaton of the business, that the equity value of the enterprise is $0." Chanos does not visit companies. Likes to focus on return on invested capital as a key financial indicator. When the accounting gets murky people tend to shy away from rigorous analysis and rely on management and just take earnings per share at face value. Therein lies the opportunity.
Tuesday, March 25, 2014
The Art of Short Selling - Wealth With Risk
Short sellers unearth facts from financial statements and from observation to ascertain that a stock is overpriced. Short sellers are information-based traders. Before 1983, no solely short funds existed. Stocks can only go to zero on the way down, but can go to infinity on the way up (reply: I've seen a lot more stocks go to zero than to infinity). Short sellers take greater risk than other investors - they must have strong evidence to support cases for price declines. Becauses reverses are sudden and terrifying, the burden of evidence rests on a solid, careful analysis completed before the stock is shorted.
Short selling is a niche. It is very small relative to the stock market as a whole. The long bias of and in the market creates exploitable inefficiencies for shorters, ie. there are more overpriced stocks than underpriced stocks (Asquith and Meulbroek). Negative earnings surprises affect stock prices to a greater degree than positive earnings surprises, and that effect persists over time. The common wisdom that there is no such thing as one bad quarter has a statistical basis. Stocks become torpedo candidates when very high expectations give way to earnings disappointments.
Short sale candidates cluster in three broad categories:
The trail signs to look for:
Accounting-based analysis is not difficult to do, but it takes time, patience and a suspension of belief.
The lack of attention by other professional investors to financial details provides the inefficiency in information dissemination that is so central to the short sellers art.
The goal is to identify the tragic flaw in a business long before the company's demise (the death rattle of a company in decline). The art of short selling trains analysts to avoid torpedo stocks or to profit from them.
The main weakness of short sellers is the inability/difficulty in judging the timing of collapse. Short sellers are consistently years too early when they sell stocks. Short sellers fear most a sustained rally in a stock.
How to make money in short selling and how not to lose money by selling are different sides of the same coin.
Short selling is a game of wits with the odds in favor of the analysts who do hard work and think for themselves, who turn jaundiced eyes on what passes for Wall St wisdom.
Short selling is a niche. It is very small relative to the stock market as a whole. The long bias of and in the market creates exploitable inefficiencies for shorters, ie. there are more overpriced stocks than underpriced stocks (Asquith and Meulbroek). Negative earnings surprises affect stock prices to a greater degree than positive earnings surprises, and that effect persists over time. The common wisdom that there is no such thing as one bad quarter has a statistical basis. Stocks become torpedo candidates when very high expectations give way to earnings disappointments.
Short sale candidates cluster in three broad categories:
- Companies in which management lies to investors and obscures events that affect earnings.
- Companies that have tremendously inflated stock prices - speculative bubble.
- Companies that will be affected in a significant way by changing external events.
The trail signs to look for:
- Accounting gimmickry: clues that the financial statements
- Insider sleaze: inurement, insider sellling.
- Fad or bubble stock pricing: large price rise over short period.
- A gluttonous corporate appetite for cash.
- Overvalued assets or an ugly balance sheet.
Accounting-based analysis is not difficult to do, but it takes time, patience and a suspension of belief.
The lack of attention by other professional investors to financial details provides the inefficiency in information dissemination that is so central to the short sellers art.
The goal is to identify the tragic flaw in a business long before the company's demise (the death rattle of a company in decline). The art of short selling trains analysts to avoid torpedo stocks or to profit from them.
The main weakness of short sellers is the inability/difficulty in judging the timing of collapse. Short sellers are consistently years too early when they sell stocks. Short sellers fear most a sustained rally in a stock.
How to make money in short selling and how not to lose money by selling are different sides of the same coin.
Short selling is a game of wits with the odds in favor of the analysts who do hard work and think for themselves, who turn jaundiced eyes on what passes for Wall St wisdom.
The Art of Short Selling - Preface
The analytical methods of great short sellers are characterized by prodigious analysis attentive to (1) the quality of earnings, (2) quality of assets, (3) and, quality of management.
You are looking for a bad business run by incompetent managers.
The years 1991 to 1993 decimated the population of short sellers. Those years saw the ascendancy of mutual funds, of momentum investing, and of the short squeeze.
(sounds eerily like 2012-2014 with ETFs, momentum investing, and short squeezes)
The simplest techniques work year in and year out - rising inventories, and insider selling.
You are looking for a bad business run by incompetent managers.
The years 1991 to 1993 decimated the population of short sellers. Those years saw the ascendancy of mutual funds, of momentum investing, and of the short squeeze.
(sounds eerily like 2012-2014 with ETFs, momentum investing, and short squeezes)
The simplest techniques work year in and year out - rising inventories, and insider selling.
Bernard Baruch on Bears
Bears can make money only if the bulls push up stocks to where they are overpriced and unsound.
Bulls always have been more popular than bears in this country because optimism is so strong a part of our heritage. Still, over-optimism is capably of doing more damage than pessimism since caution tends to be thrown aside.
To enjoy the advantages of a free market, one must have both buyers and sellers, both bulls and bears. A market without bears would be like a nation without a free press. There would be no one to criticize and restrain the false optimism that always leads to disaster.
Quote at the beginning of "The Art of Short Selling."
Bulls always have been more popular than bears in this country because optimism is so strong a part of our heritage. Still, over-optimism is capably of doing more damage than pessimism since caution tends to be thrown aside.
To enjoy the advantages of a free market, one must have both buyers and sellers, both bulls and bears. A market without bears would be like a nation without a free press. There would be no one to criticize and restrain the false optimism that always leads to disaster.
Quote at the beginning of "The Art of Short Selling."
Subscribe to:
Posts (Atom)