I Don't Short Stocks, Thank You Very Much

I would not like them here or there. I would not like them anywhere. I do not like green eggs and ham. I do not like them Sam I Am. --Dr. Seuss

I am an investor. A long-only investor. Sure, I dabbled in shorting a little bit some years ago, but my reaction was much like former President Clinton's explanation of his experimentation with marijuana: "I experimented with shorting a time or two, and didn't like it. I didn't inhale, and I didn't try it again."

Some might go as far as to call me a Warren Buffett fanboy. As such, I'm dead set on finding high-quality, well-run businesses selling at a discount to their intrinsic value. It's as simple as that.

Or is it ...
My fellow Fool Matthew Argersinger penned an article recently titled "Forget Buy and Hold, Think Buy and Short." "Outrage" best describes my reaction to the article's title. 

"Great," I thought, "one more attack on the tried-and-true idea of investing in stocks as businesses and profiting from their long-term growth and success." But I bit my tongue and read on.

As it turns out, Matt made a pretty compelling case, citing, among other things, a study of individual stocks between 1983 and 2006 -- a period that saw the price of the S&P 500 index multiply 10 times over. The study wasn't terribly promising for those looking to find outperforming stocks. It found that:

  • 64% of stocks underperformed the Russell 3000 during that span, dividends included.
  • 39% of stocks had a negative lifetime total return.
  • 19% of stocks lost at least 75% of their value.

Ouch!

Of course, the long-only investor in me would rebut that it's often not all that hard for investors who do their homework to separate the investment wheat from the chaff. Even just looking at valuation can go a long way toward keeping you away from stocks headed the wrong way.

Take Wal-Mart and Pfizer (NYSE: PFE  ) . Both stocks would have been considered big winners among the group of stocks in action over the 1983-2006 period -- Wal-Mart soared 5,826%, while Pfizer was up more than 1,700%. And that's without dividends.

The past decade hasn't looked quite so good for either company, though. During the decade ended in January of this year, Wal-Mart's stock lost 23%, while Pfizer slid 44%. What happened? Very respectable operating income growth of 9.3% per year for Wal-Mart and 8.6% for Pfizer couldn't fight the enormous valuations both companies carried 10 years ago.

Not quite the whole story
OK, actually it's not even close to the whole story. While valuation plays a big part in stock returns, there's a lot more to the results of the study above than high earnings multiples. Quite simply, in terms of business model alone, there are a lot of very mediocre companies trading on the public markets, not to mention some downright ugly companies. (Remember Webvan?)

But wait, there's more! Father Time isn't always kind to businesses and industries -- ask Eastman Kodak and New York Times about that. As Lehman Brothers, Citigroup (NYSE: C  ) , and a host of other big banks showed, execution is often nothing short of pathetic. And sometimes, as with Enron, management is just plain criminal.

Perhaps I could like green eggs and ham?
I surely am not interested in giving up my focus on buying quality companies. But the more I thought about it, the more intrigued I became about the idea of selectively shorting companies. So I reached out to Matt Argersinger to find out more about what he and forensic accounting expert John Del Vecchio, CFA, have been focusing on in their shorting efforts.

I came away from our exchange with three reasons to consider adding shorting to my toolbox:

  1. Hedge: I don't think our economy is in for a horrorshow, but I do recognize that there are some very real challenges ahead. A few short positions could provide a hedge against losses across the rest of my portfolio.
  2. Making the most of research: Research enough companies looking for long opportunities, and you're bound to stumble across a few companies that make you scratch your head and say, "How in the world is this company in business?" You can leave those stocks alone and move on, or you can spend some time to dig in and potentially make money on the downside as the rest of the market comes to the same conclusions that you did.
  3. Non-correlation: Finding the right short can potentially hand you a trade that will make money no matter which way the market moves. If the company in question has poor quality earnings or appears to have other accounting shenanigans going on -- a specific area that John and Matt are focusing on -- it may not matter what the market is doing when investors begin to realize the company isn't on the up-and-up.

A starting point
One of the primary ways John and Matt are looking for short opportunities is by keeping an eye out for red flags in financial performance. One of those red flags is when a company's cash flow lags its accounting profits. Wall Street tends to focus on income statement earnings, but if a company can't turn those earnings into cold, hard cash, then those earnings aren't worth a whole lot to investors.

Using Capital IQ, I was able to find a handful of companies that are currently waving this red flag. To make the numbers comparable, I looked at the net income-operating cash flow disparity as a percentage of net income.

Company

Last 12 Months Disparity as a % of Net Income

2009 Disparity as a % of Net Income

2008 Disparity as a % of Net Income

RINO International (Nasdaq: RINO  )

156%

45%

72%

China Security & Surveillance (NYSE: CSR  )

131%

7%

220%

Ebix (Nasdaq: EBIX  )

12%

13%

2%

Yongye International (Nasdaq: YONG  )

100%

200%

165%

Source: Capital IQ, a Standard & Poor's company, and author's calculations.
Disparity percentage is net income less cash flow from operations divided by net income.

Nota bene! I am not recommending that you rush out and short these stocks. Often there are very obvious explanations for why cash flow is trailing accounting net income. For instance, Visa (NYSE: V  ) showed up on my screen, but even a quick glance at its cash flow statement shows that payouts on legal settlements have made the company's cash flow look wacky.

In the case of the companies above, growth might be proffered as an explanation, since growing receivable balances, inventories, or both are the primary culprits for the net income/cash flow disparity.

This can be a reasonable explanation; however, it's also something that investors need to watch very closely. Overinvesting in inventory can leave a company with warehouses full of depreciating products, while prodding sales growth by giving overly accommodative credit terms to new customers can come back to haunt a business as well.

After digging in, if an adequate explanation of a persistent gulf between accounting income and cash flow can't be found, or the explanation smells fishy, you may just have short-worthy shenanigans going on.

If, like me, you're interested in further exploring green eggs and ham ... I mean, using a portion of your portfolio for smartly chosen shorts, enter your email in the box below. We'll send you a new report, "5 Red Flags -- How to Find the Big Short," by John Del Vecchio, CFA, a leading forensic accountant who has made a good deal of money identifying companies with low-quality earnings. Simply enter your name in the box below -- the report is free.

Pfizer and Wal-Mart are Motley Fool Inside Value recommendations. Ebix is a Motley Fool Rule Breakers choice. Yongye International is a Motley Fool Global Gains recommendation. Motley Fool Options has recommended a bull call spread position on Ebix. The Fool owns shares of Ebix and Yongye International.

Fool contributor Matt Koppenheffer owns shares of Wal-Mart, but does not own shares of any of the other companies mentioned. The Fool's disclosure policy assures you that neither Sam I Am nor Matt Koppenheffer have any stake in GreenFoods Industries, the sole global supplier of green eggs and ham.


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  • Report this Comment On August 23, 2010, at 4:56 PM, plange01 wrote:

    i dont like shorting stocks either but i like money and a lot of it! i learned long ago not to have expectations but to take what the market will give.try the etf/s that short they are easy to buy and will give you a easier chance to cover your longs or make a little extra cash .down the road if you start to feel more comfortable then try a individual stock..

  • Report this Comment On August 23, 2010, at 5:09 PM, IFKAR wrote:

    Who was it that said, "The market can stay irrational for a lot longer than you can stay solvent"? Put plainly, you can short the worst stock in the world, but it doesn't mean that Mr. Market will recognize its worthlessness before you go bankrupt. A shorted stock has unlimited loss pontential, like borrowing with a blank check.

    I'll stay long, thank you very much.

    Marty

  • Report this Comment On August 23, 2010, at 5:11 PM, TMFHockeypop wrote:

    I love it. Shorting TMF recommended stocks. Shows the independence on the Fool. Thank you Matt. I still won't short, but I appreciate your analysis.

  • Report this Comment On August 23, 2010, at 5:28 PM, Borbality wrote:

    You say you don't like shorting but then give tips on how to short. Seems like the Fool is really catering to this type of investor.

    There is money to be made shorting, for sure, but I feel the market is already irrational enough when trying to find winners, let alone when seeking losers.

  • Report this Comment On August 23, 2010, at 5:29 PM, TMFKopp wrote:

    @IFKAR

    Was that a potentially apocryphal Jesse Livermore quote? Yeah, I can't seem to remember either...

    That same contention is one of the reasons that I've never been hot on the idea of shorting. When you go long, your max loss is capped at whatever you invested. As you point out, there is no max when you short (well, potentially when you go broke).

    I think there are two potential answers to your issue though. First, in the past, the few shorts that I tried were focused on companies that had high-flying stocks that I believed were overvalued and potentially just bad businesses. However, when the market loves a stock, I think that's one of the prime times that you can get burned by that irrationality that you note. CROX was a perfect example of this for me... irrationality lasted way longer than I figured.

    A focus instead on funny accounting practices (as opposed to overvaluation) CAN be a better way to go because if accounting irregularities are identified investors are generally much less apt to be forgiving. Additionally, financial statement red flags can be precursors to a slowdown in sales or profits and that's kryptonite for a high-flying growth stock.

    The other answer to your issue is time-line / loss caps. Being a long investor, I'm not used to putting short timeframes on my investments -- if I find a good company that's at a good price I'll buy and hold it until it gets wildly overvalued. Talking to Matt, he suggested that with shorting you're ideally setting much shorter time frames on your thesis. At the same time, it would be prudent I imagine to cap the size of the loss you're willing to take (though I'm NOT a fan of stop-losses on longs).

    Maybe this is just me thinking out loud, but I definitely had that exact same hangup.

    Matt

  • Report this Comment On August 23, 2010, at 5:32 PM, TMFKopp wrote:

    @hockeypop

    "I love it. Shorting TMF recommended stocks. Shows the independence on the Fool. Thank you Matt. I still won't short, but I appreciate your analysis."

    Trust me, I didn't throw those names up there lightly -- particularly EBIX, which is a business I actually like. However, those net income / cashflow disparities that I came up with are, if not true red flags, then definitely strong yellow flags.

    But to your point, there are no sacred cows here at TMF and I think the site, services, and community are all better for it.

    Matt

  • Report this Comment On August 23, 2010, at 5:38 PM, TMFKopp wrote:

    @Borbality

    "You say you don't like shorting but then give tips on how to short."

    Just to clarify, I explain that I never have been a fan of shorting, but then explain why my opinion may be changing and suggest some reasons why adding some shorts to a portfolio can be a good idea.

    Don't get me wrong, my portfolio is and always will be mostly either long or long along with cash that's waiting to go long. However, I think that having some short positions in a portion of a portfolio could be a good idea.

    "There is money to be made shorting, for sure, but I feel the market is already irrational enough when trying to find winners, let alone when seeking losers."

    Check out point #2 of the three reasons to consider going short above. I don't believe you need to vastly change your research strategies to find short opportunities. I know that over the years I've definitely come upon awful looking companies while looking for long ideas.

    I think particularly if you're a value/deep-value investor this may be the case -- there's often a thin line between a company that has been beaten up but still has significant value and a company that has been beaten up and has even more trouble brewing.

    Matt

  • Report this Comment On August 23, 2010, at 5:41 PM, ragedmaximus wrote:

    like a adam sandler movie quote"WHOOPDIDOO"! lol lol lol

  • Report this Comment On August 23, 2010, at 6:34 PM, richie54 wrote:

    Right on, Matt.

    Tomorrow, let's hear your take on options.

  • Report this Comment On August 23, 2010, at 6:46 PM, XMFRael wrote:

    great debate... i think the quote may have been Keynes... and i always thought it was BS. i mean a long-and-strong investor (like me) -- who doesn't mess with margin -- can stay solvent pretty much forever. I also haven't shorted in the past. But I've seen people make a ton of money doing it. i think matt hits it right on the head: short companies that are doing something wrong. eventually they will get caught and punished. but short on valuation at your own peril. i especially love short research (the forensic accounting stuff) for one reason: it doesn't rely on forward-looking profit estimates -- which i think are very difficult to make.

  • Report this Comment On August 23, 2010, at 7:08 PM, myEnergyPlay wrote:

    What about shorting For-Profit schools like APOL and ESi?

    Thanks

  • Report this Comment On August 23, 2010, at 7:48 PM, TMFKopp wrote:

    @richie54

    Now you're just pushing my buttons :)

    In very short form, I could say some very similar things about options. However, when it comes to options you have the additional option valuation math, so it's not as quite of an easy plug-and-play between long and options as I see between long and short.

    Matt

  • Report this Comment On August 23, 2010, at 7:53 PM, TMFKopp wrote:

    @TMFRael

    "but short on valuation at your own peril."

    Ugh... alas, I know this is only too true...

    "i especially love short research (the forensic accounting stuff) for one reason: it doesn't rely on forward-looking profit estimates -- which i think are very difficult to make."

    I agree with this. I do use forward-looking estimates and I try to kick tires as much as I can to get something that'll actually make sense, but boy is it tough to predict the future like that.

    But yeah, when a company is doing something fishy with its accounting that's now, real, and scary -- no crystal ball needed. And typically when you find one scorpion there are five more hiding out (or at least that's what my exterminator tells me... I'm busy trying to eradicate my house...).

    Matt

  • Report this Comment On August 23, 2010, at 8:06 PM, pstoimenov wrote:

    Shorting is a tool which is not a necessity for the successful investor. You can be good investor without ever shorting a stock. The same applies to options.

  • Report this Comment On August 23, 2010, at 8:10 PM, badia100 wrote:

    see this bothers me why is ebix on this list, 13% parity between cash flow,and earnings is normal for a company thats has bought 3 companys in 2 yrs. byt the author dont tell ya this. its another case of bad reporting and pubic making bad decisons on bad reporting...13% is nothing compare to tothers on this list ,and other who should really be on this list..so i ask again...WHY IS EBIX ON THIS LIST ?...DID YOU SHORT IT ? 3RD LARGEST GROWING COMPANY IN THE WORLD,,your reporting is off base. ebix gonna shock you all.

  • Report this Comment On August 23, 2010, at 8:13 PM, ChrisBern wrote:

    @IFKAR - puts don't have unlimited loss potential. In my opinion just sprinkling in some puts to a net long portfolio is a great way to hedge.

    Great article, and I agree completely. 2 years ago I found out the hard way another major reason to have some short positions in an otherwise long portfolio--when stock prices tumbled and valuations were incredible (think March 2009), I had ZERO money to put into stocks! Why? Because I was 100% long. Even if a person is 90% long and 10% short, that 10% short position would rise in a down market, and you could sell that position at a high price and buy up some more longs at a low price.

  • Report this Comment On August 23, 2010, at 8:20 PM, TMFKopp wrote:

    @pstoimenov

    You know, that's a sentiment I probably would have echoed for most of my investing life. And it probably is mostly true -- as far as I know Lynch never did much else besides go long individual stocks.

    However, look at a great many of the names that hang in the investing hall of fame. George Soros and Seth Klarman use a wide variety of instruments and these two have produced some really unbelievable results. Even Warren Buffett -- he's got those derivatives that have been wreaking havoc on Berkshire's P&L, he took those big preferred stock positions (which included warrants) on GE and GS, and the companies that he buys outright... well, that's just private equity by another name.

    I believe one of the things that characterizes the best investors are those that are able to be flexible and find value where value is rather than be constrained by a specific idea of what value investing is supposed to be. Of course, some (Lynch, Muhlenkamp, etc) are constrained by the funds they manage and still have managed to do well...

  • Report this Comment On August 23, 2010, at 8:30 PM, 2beewise wrote:

    My experience has been that if I follow the MF lead, I make money, so I'm willing to put my money on their wisdom in the shorting game too.

  • Report this Comment On August 23, 2010, at 8:40 PM, TMFKopp wrote:

    @badia100

    "see this bothers me why is ebix on this list, 13% parity between cash flow,and earnings is normal for a company thats has bought 3 companys in 2 yrs. byt the author dont tell ya this."

    I'd be interested to hear your explanation as to why it's "normal for a company thats has bought 3 companys in 2 yrs." to have a persistent gap between net income and cash flow.

    Maybe I'm missing something, but in EBIX's annual report the company discusses it's three 2009 acquisitions and it doesn't appear that accounts receivable were added in any of those acquisitions -- it was primarily goodwill.

    The largest of the three acquisitions was E-Z Data at ~$50m. $43.8m was goodwill, $14.2m was an indefinite-life intangible asset, $3.8m in other intangible assets, $418k in non-competes, and $2.3m in acquired developed technology.

    Between 2008 and 2009 EBIX saw 31% growth in revenue, similar 34% growth in accounts payable, and matching 34% growth in accrued payroll and benefits -- the latter two of which are cash inflows on the CF statement. However, accounts receivable jumped 69%. Why?

    The reason I highlighted EBIX here is that I don't have an explanation for that and if it continues to persist I see it as troublesome. I haven't shorted it, but I'm continuing to look into the situation. I'm all ears to any explanations that show why there's nothing to worry about. I actually like EBIX's business.

    Matt

  • Report this Comment On August 24, 2010, at 12:01 AM, dhm wrote:

    This last week I spent my time recording trades from the last 15 years into my scorecard, I found I lost quite a bit of money shorting stocks. This was not because the position didnt go down, but because knowing that there is no limit to the potential loss, I was not mentally prepared to stay the coarse when the position moved higher. Over 70 positions that I traded a few years ago are no longer in bussiness. Only around 30 percent are higher now than then. I think shorting can be profitable for the right person, but not me.

    Doug

  • Report this Comment On August 24, 2010, at 12:09 AM, badia100 wrote:

    matt, you mention "5 red flags" but discuss one. re:disparity.

    in the case of ebix,its was 13% in 2009,and now 12%,in 2010. they bought 3 companys in 2009 for $65 million total..could be the disparity difference yoy.

    my problem with ebix on the list,is wheres first solar,badiu,msft..12% doesnt mean anything..when you are growing your business..and ebix is,i think your cloum is a negative ploy to discredit a fortune 500 fastest grwing company for know reason.--short intrest is high,and thats a good thing,,the squeeze will be bigger(35million shares will cover )..all the stocks and you put ebix on this list. c;mon!!...and where are the other 4 flags...ebx doesnt qualify to be on this list ,,you know it.now give it the buy rating that it deserves. its a 50.00 stock..not a 10.00 stock..good try

  • Report this Comment On August 24, 2010, at 12:11 AM, badia100 wrote:

    ebix is only name on list that has improved from 2009 to 2010--the others all got worse...why is it in this article..

  • Report this Comment On August 24, 2010, at 4:10 AM, TMFKopp wrote:

    @badia100

    A few quick thoughts for you...

    - The five red flags refer to the free report that you can sign up to receive and are separate from my article here.

    - Regarding EBIX's disparity and its acquisitions, I'll refer you back to my comment above -- it doesn't appear that the acquisitions had anything to do with receivable balances. I'm all ears (eyes?) if you can point me to something that says otherwise.

    - FSLR, BIDU, and MSFT don't appear on this list because all of those companies produce cash flow in excess of their accounting income.

    Matt

  • Report this Comment On August 24, 2010, at 8:49 AM, bruwin48 wrote:

    EBIX - Latest Q2 Results.

    9th. August 2010.

    In their latest set of results, EBIX has shown an increase in virtually every positive item.

    The percentage Quarterly Revenue increase is not as it was several quarters ago, but it has nearly doubled in the last 3 months.

    EBITDA Margin and Bottom Line Margin are both well up, and sit at 48.1% and 43.5% respectively.

    Pretax Return on Cap.Employed is also up from 19.8% to 21.5%.

    Basic EPS is also up by 11% to 40c.

    The share price opened at $17.16c today, and is currently trading at over $18.60c, which is the highest since 4 Nov. 2009.

    It will be interesting to see how the Short Sellers of EBIX react, .... going forward.

    Don't know about others, but I'll certainly be hanging onto my company stock.

    EBIX Quarterlies :- 09/03 09/06 09/09 09/10 10/03 10/06 Revenue 20.7 22.4 23.3 31.3 31.6 32.2CoS 4.1 4.5 4.5 8.0 7.0 7.4SG&A+R&D 7.5 7.8 8.1 10.0 10.4 9.3EBITDA 9.1 10.1 10.7 13.3 14.2 15.5Interest Expense 0.3 0.3 0.2 0.3 0.3 0.3Pretax Income(TTM) 31.3 33.9 35.8 39.8 44.3 49.4Net Income 8.3 9.0 9.4 12.1 12.4 14.0 Capital Employed 95.7 120.7 124.2 187.1 223.4 230.1 Revenue Increase 8.2% 4.0% 34.3% 1.0% 1.9% CoS/Revenue 19.8% 20.1% 19.3% 25.6% 22.2% 23.0%SG&A+R&D/Revenue 36.2% 34.8% 34.8% 31.9% 32.9% 28.9%EBITDA/Revenue 44.0% 45.1% 45.9% 42.5% 44.9% 48.1%Int.Expense/EBITDA 3.3% 3.0% 1.9% 2.3% 2.1% 1.6%Pretax Inc./Cap.Employed 32.7% 28.1% 28.8% 21.3% 19.8% 21.5%Net Inc./Revenue 40.1% 40.2% 40.3% 38.7% 39.2% 43.5% Basic EPS (Cents) 28 29 30 36 36 40

  • Report this Comment On August 24, 2010, at 9:01 AM, bruwin48 wrote:

    Unfortunately the Table of Percentage Ratios didn't come out as planned. So I've tried again ..

    EBIX Quarterlies :- 09/03 09/06 09/09 09/10 10/03 10/06

    Revenue Increase 8.2% 4.0% 34.3% 1.0% 1.9%

    CoS/Revenue 19.8% 20.1% 19.3% 25.6% 22.2% 23.0%

    SG&A+R&D/Revenue 36.2% 34.8% 34.8% 31.9% 32.9% 28.9%

    EBITDA/Revenue 44.0% 45.1% 45.9% 42.5% 44.9% 48.1%

    Int.Expense/EBITDA 3.3% 3.0% 1.9% 2.3% 2.1% 1.6%

    Pretax Inc./Cap.Emp. 32.7% 28.1% 28.8% 21.3% 19.8% 21.5%

    Net Inc./Revenue 40.1% 40.2% 40.3% 38.7% 39.2% 43.5%

    Basic EPS (Cents) 28 29 30 36 36 40

  • Report this Comment On August 24, 2010, at 9:33 AM, voltnfan wrote:

    Ebix free cash flow certainly appears to be moving very strongly in the right direction and continually improving:

    Year Free Cash Flow

    2000 (7.8)

    2001 (3.4)

    2002 (1.3)

    2003 2.8

    2004 2.4

    2005 5

    2006 3.6

    2007 12.7

    2008 26.2

    2009 30.8

  • Report this Comment On August 24, 2010, at 11:03 AM, badia100 wrote:

    back to my original question. why is ebix on this list ?

    you could of put 50 other high enders media hypes on it..why ya picking on ebix...your just gonna be proved wrong. mention possible short squeezes of short squeezes..coming,,ceo 's plans..triple vloume..not this crap..and like i said its gone from 13% to 12%,,thats improving..your article should state that...this a negative article on a positive company..but you know this.

  • Report this Comment On August 24, 2010, at 8:17 PM, ikkyu2 wrote:

    The quote about Mr Market was Benjamin Graham from "The Intelligent Investor."

    The transaction involved in shorting stocks is a great idea. No matter whether the underlying stock goes up or down; no matter whether the market goes up or down; the individual involved in the transaction makes money.

    No, I'm not talking about you, doofus, the guy who's looking for a name to short against the tape. I'm talking about the guy whose shares you borrowed and then sold short. You're in a transaction with that guy, usually your brokerage house, and they make money regardless of whether you do or not. You pay them their vig. They lend you the shares - and get them back when they want them.

    Why would you want to be half of a transaction where you're taking a risk of loss, when your counterparty is assured of a guaranteed revenue stream and getting their shares back in the end anyway? Doesn't make sense.

    "If you can't spot the sucker at the table, it's you."

  • Report this Comment On August 25, 2010, at 12:16 AM, rfaramir wrote:

    My number one reason to not short is inflation. Shorting is in nominal dollars, but the Fed is printing like crazy and the dollars may end up in the stock market, pushing prices up without a real change in value.

    On CAPS, on the other hand, an Underperform is not really a short, it is a relative-short. Relative to the S&P 500 index. So as the market as a whole inflates, the stock you pick to Underperform may actually go up, but less than the S&P, so you can still 'win'.

    Special situations can still be found, when you see a company that just has to fold the way it is going. But an easy money policy tends to keep zombie companies alive when they should die: they can borrow at near zero to keep their failed model floating a little longer. So such things will be few and far between in a potentially heavy inflation environment. (And I say "potentially" because at the moment the market is trying to correct mal-investments which looks like deflation.)

  • Report this Comment On August 25, 2010, at 1:50 AM, Jehnavi wrote:

    Do not get me wrong, my wallet is and always will mostly long or more with money waiting too long. However, I must have short positions in a portion of a portfolio can be a good idea.I also have a short circuit in the past. But Ive seen people make a ton of money to do so. I think Matt was on the head: young companies that are doing something wrong. eventually get caught and punished.

    http://www.financemetrics.com/

  • Report this Comment On August 25, 2010, at 1:30 PM, JaysRage wrote:

    This is a nice list of some of the fastest growing under-valued small caps out there. Good luck shorting this list. It looks like a sure-fire way to put yourself in the poor house. 3 out of 4 are on my long-term BUY list, including EBIX, which has great cash flow. These are high-growth stocks. Cash will follow.

  • Report this Comment On August 25, 2010, at 3:26 PM, matban wrote:

    Short EBIX, ay? I just love the smell of a short squeeze. I went long again on this one today and fully expect a good short squeeze this month. There is a whole website devoted to the shortsqueeze ratings of stocks...I haven't looked there yet, but I did the last time I won on this investment.

  • Report this Comment On August 25, 2010, at 3:50 PM, ikkyu2 wrote:

    "young companies that are doing something wrong. eventually get caught and punished."

    This is a recipe for how to get screwed trying to short something. Shorts are short-term trades. "Eventually" may not happen "shortly." What will happen, assuredly, is a margin call, and now you're throwing good money after bad.

  • Report this Comment On August 25, 2010, at 4:08 PM, TMFKopp wrote:

    To the folks looking at EBIX -- what I will say is that the short interest is a pretty scary thing for potential short sellers. As I noted in the article, those weren't meant to be open-and-shut short-sells, they were places to start investigation and the high short interest is definitely a factor that needs to be weighed.

    High short interest is actually an area that John Del Vecchio likes to look at as a danger sign for short sellers. I was just reading over his materials again yesterday, it's really good stuff -- anyone that's even just curious about shorting I encourage to sign up above to get his report.

    Matt

  • Report this Comment On August 25, 2010, at 4:50 PM, JaysRage wrote:

    I agree with that last statement. I see a high short interest as a bullish flag. Just like longs, the dumb money is late to the game. If the short interest is really high, you're looking at a bottom and a coiled spring for upward growth.

  • Report this Comment On August 26, 2010, at 7:08 PM, TMFFuz wrote:

    Most stocks actually under-perform the market over time (it's a fact anyone can look up). One way to take advantage of this is to have a strategy to short a stock and take a long position in the index and hedge your short. If you have an approach that can identify under-performing securities like forensic accounting does, this is a way to mitigate risk.

    I managed a fund that did exactly this. It shorted individual stocks and was long the S&P 500 on an equal weighted basis. I am not sure what I can actually say about the performance, but I will say that the performance was consistent with very smooth returns that vastly out-performed the markets, mutual funds, and most hedge funds.

    The best traders I know -- the ones who actually make money trading -- actually have a hedge / spread on every trade they make. They don't take outright positions.

    The notion that your risk is unlimited in shorting is also unrealistic. Risk management is critical whether you go long or short. Why is it that Bill Miller is considered a genius yet he consistently bought bankrupt companies all the way down to zero? Lowest Average Cost Wins is a quick way to the poor house.

  • Report this Comment On August 27, 2010, at 11:09 AM, 1LONGPAN wrote:

    MY INVESTMENTS ARE IN PORTFOLIOS OF

    IRAs WHERE OPTIONS-SHORTS ARE NOT

    ALLOWED. I GUESS I'M CHPPED LIVER AND

    THERE ARE NO "EXPERTS" HATCHING MY

    DOLLARS.

  • Report this Comment On August 27, 2010, at 11:47 AM, trlucas wrote:

    Last time I shorted something my broker (Charles Schwab), for no discernible reason, closed my short position after a week or so, losing money for me.

    It makes me leery of ever shorting stocks. Do all brokers do this?

  • Report this Comment On August 27, 2010, at 1:07 PM, bgix wrote:

    I refuse to short for moral reasons.

    I have nothing against people making money, or even people making "a lot" of money. However, I do have a problem with intentionally profiting from the misery or misfortune of others.

    Shorting of course has two aspects: a Gambling aspect that is inherently riskier than a long investment due to unlimited downside, and also decapitalization effect (when it works) that affects the broader market. Now, I have no problem with people who short and lose. In fact I find it amusing when the cynics lose.

    But successful shorting punishes the optimists. Investing in the market is the ultimate exercise in optimism of our free-market system. It says that you believe in the Market (or at least that individual company). Generally speaking, I believe optimism should be rewarded, particularly when you have done the work required to find a winner. But when you successfully Short, you are doing nothing more than skimming off the top of well-meaning, but misguided (or simply non-attentive) optimistic investors.

    However, most people in the market today are exactly this kind of investor. They want to retire. They want to pay for their kids college. They are contributing to the GDP, and don't have the time to examine the day-to-day movements of the market. The money made by successful shorting doesn't appear from mid-air. It comes primarily from those optimistic investors. It depresses their retirement, and shrinks their college funds.

    So when I lose faith in the Markets or particular companies, I sell the stocks that I actually have. I perhaps shift my investments to lower yielding bonds or CDs, or even better, find someone else to be optimistic about. And I applaud when the optimism that others had, when I didn't is pays off for them.

    I also don't short stocks, thank you very much.

  • Report this Comment On August 27, 2010, at 4:51 PM, TMFKopp wrote:

    @bgix

    "But successful shorting punishes the optimists."

    While this may be true, I don't think we should be blindly rewarding optimists -- sometimes they're dead wrong. For our economy to work correctly we need to see good businesses thrive and bad businesses get weeded out.

    As this pertains to shorting I'd suggest two things:

    1) Those that short good, solid companies are going to get their heads handed to them in the vast majority of cases. Maybe the shorts can have an impact in the very short run, but unless the company is desperate for public market funding, that is unlikely to have a real impact on the business and success/profits will eventually break the shorts' backs.

    2) The companies that make the best shorts -- those companies that are working accounting shenanigans or are downright criminal -- should be weeded out. In this case the shorts play a beneficial role in helping to dig up bad eggs.

    In short (pun intended), short selling only punishes the optimists when the optimists are wrong.

    Matt

  • Report this Comment On August 27, 2010, at 5:38 PM, bgix wrote:

    @TMFKopp

    I totally agree that the companies "that make the best shorts" should be weeded out. Also the ones that are simply incompetent. But I don't see shorting as accomplishing that. It may well (and probably does) accelerate the process, but at the end of the cycle, the margin calls come, and there are the exact same number of outstanding shares. The serious money that has changed hands is amongst the share-holders. Those bad eggs will be weeded out with or without short sellers, because there will be plenty of HOLDERS dumping.

    If anything, I think that shorting gives the white collar "criminal" element at bad companies yet another potential way to profit from their shenanigans. But of course that has nothing to do with my decision not to short.

    I don't mean to tell anyone that they should use my particular moral compass. Just another reason why I agreed with your article.

  • Report this Comment On August 28, 2010, at 12:30 AM, Modalics wrote:

    I consider a balanced portfolio one which contains about half stocks that are trending up and half that are trending down and I trade short about as often as long. That way 1) if the market crashes I won't have to jump out of the window, 2) I make money whether the market moves up or down, 3) All stocks vibrate up and down and it is fun to make money on both the ups and downs because essentially you double your gains, and 4) when you have about the same amount of capital invested short as long, you essentially have double the amount of capital in play. Besides when you work hard to find stocks that are fundamentally strong, when that changes (and everything always changes) the change will most likely be for the worse... and visa-versa. I gain about 10 to 20% on my invested capital each month doing it this way so and that makes me happy - it might take years for a fundamental long investor to make the gains I make in a month. I see nothing morally wrong with shorting stocks. For more information on how to invest this way, checkout www.modalics.com. Don't be afraid to jump in the water is fine!

  • Report this Comment On August 28, 2010, at 9:53 AM, x937 wrote:

    My friend got burned bad with shorts...they called her shorts...(during a dead cat bounce...lol).

    I walked away with some valuable knowlege...if a stock is overshorted, then sometime in the future, it's going to bounce up when the people try to exit their shorts (and buy the stock).

    I love the herd, and I've made money on the herd...buying overshorted stocks.

  • Report this Comment On August 28, 2010, at 1:52 PM, christahorvath wrote:

    I thoroughly enjoy learning from professionals each arena. You expertise is greatly appreciated.

    Thanks for all you do.

  • Report this Comment On August 28, 2010, at 2:03 PM, XMFRael wrote:

    Mod, for what it's worth, Tom Gardner talks a lot about your first reason -- pointing out how important temperament can be when investing. The cushion a minority short position offers when markets get crazy can be just enough to prevent us from doing something CRAZY. Granted, cash does a little bit of the same thing, only not as well in my view. Disclosure: I don't short stocks either, but I think that smart investors do.

  • Report this Comment On August 28, 2010, at 8:19 PM, Modalics wrote:

    I have done eighteen plays since 7/9 when I began posting all my trading plays on my website and suffered a loss on only one play. That was a BUY to SELL play where I was bucking the trend and I kept on buying and buying because the Modalic predictions told me to. I finally sold out in frustration and will be dropping that unpredictable stock from my portfolio. My point is that you can loose money in the stock market in lots of ways but usually it is stubbornness as was the case with me on this one. If you want to review my last eighteen plays including this one, click www.modalics.com/log.html. ModalMan.

  • Report this Comment On August 29, 2010, at 12:16 PM, Modalics wrote:

    It is risky to short stocks that are trending up although I do it all the time when all the Modalics of the stock are all falling, but you have to be careful to cover before the Modalics rise again - this is the lesson I learned with $DELL a couple weeks ago. I invite you to check out my trading log to see how a Modalic trader makes good money in the market (www.modalics.com/log.html). By the way I don't charge any fees for the information I give so if anybody thinks I run some kind of internet scam service, you couldn't be wronger (is that a word yet?). ModalMan.

  • Report this Comment On August 29, 2010, at 12:24 PM, Modalics wrote:

    Opps, for some reason the link I gave in my previous post does not work - if you are interested in my trading log, then click www.modalics.com and when you get there, click the "LOG" link that appears on the home page. Sorry about that. ModalMan.

  • Report this Comment On August 29, 2010, at 11:32 PM, HardnoseDotCom wrote:

    I am bullish most of the time and hold only long stock positions. I hedge my portfolio to a market-neutral position when I am bearish about the market, not about individual stocks. I used shorts for a while, but am now using puts. August has been a perfect month -- my long positions have gone up and my hedges have gone down.

    Shorts do not tie up capital but losses are unlimited, dividends are charged against your account, the daily marking to the market makes your account statement difficult to understand, a negative cash balance with the concomitant exorbitant interest charges can occur, and sometimes shares are not available for shorting.

    Losses on puts are limited to their cost. However, puts tie up a little capital and the cost of the puts reduces profit.

    PS: to trlucas: My broker, TD Ameritrade, sent me notices that they might have to cover my shorts because shares for shorting were no longer available. This is probably why your broker covered.

  • Report this Comment On August 30, 2010, at 7:52 PM, MAXwolf wrote:

    While shorting a stock does in theory offer you unlimited loss potential, there are tools to be used.

    A stop loss can be employed and you can decide how much heat you are willing to bear. Stocks, hundreds of them are shorted every day, many times. Ford has an average volume per day of 75,052,800 shares traded (per Yahoo finance). Does anyone really think those are all long buy and hold positions? If so, in short order there wouldn't be any Ford to trade, they would run out of shares and I have no idea what the demand (one sided) would do to the price.

    Most stock transactions are "trades" made by traders. They buy something, or sell something and take a profit. It keeps valuations in line and creates a market for when YOU want to sell. Thanks, MAX

    PS: If you are not using a stop loss your longs, while not unlimited, losses can massive. I have couple of worthless companies; and would you like to be sitting on RIMM at $14x.xx (someone is), it is trading at about $47.

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