You Can't Win in This Market

To look at my email inbox, you'd likely wonder whether:

(a) My friends are all exiled Nigerian bankers with loads of excess cash.
(b) I'm on more medication than Britney Spears.
(c) Hedge funds and short-sellers are out to destroy me.

Since neither "a" nor "b" have much to do with investing -- unless, that is, you're betting on the burgeoning futures market built around the odds of Britney's next stint in jail or rehab -- let's focus on "c". Should I be paranoid about hedge funds and short-sellers? A reader thinks so. Here's what he wrote to me recently:

"Please help us smaller investors to fight against the naked short selling and stock manipulations in our market. Small investors have no chance to win at all. (Emphasis added.)"

Really? I beg to differ:

Company

52-Week Return

Short Interest

Ascent Solar (NASDAQ:ASTI)

419.7%

50.20%

Cal-Maine Foods (NASDAQ:CALM)

165.5%

60.78%

Blue Nile (NASDAQ:NILE)

50.8%

32.63%

Sources: Nasdaq Reg SHO list, Yahoo! Finance, shortsqueeze.com

Yes, Virginia, there is a Santa Claus ... and his name is Mr. Market
Each one of these stocks has spent months, and in some cases years, on the Nasdaq's Reg SHO list, which identifies firms commonly thought to be the subject of short attacks. Especially naked short attacks. Yet owning any one of them over the past year would have helped you to crush the market in grand fashion.

Now, does that mean you should buy every stock on the Reg SHO list? Certainly not. There are some pretty bad businesses on that list. Closeout retailer Overstock, though improving, may be one, thanks to a long and sordid history of capital destruction.

My point is this: While it's true that prices can't move up when there are more sellers than buyers, given time, excellent businesses always draw more buyers than sellers eventually.

And that spells opportunity for you, the belled-cap small investor who doth call himself Fool.

Here's why. Short-sellers tend to have a very short timeline for investing, and understandably so. There's no limit to the losses for short-sellers who bet against a stock that turns north.

Thus, when they err by shorting companies with outstanding fundamentals, short-sellers create temporary price depressions that enable massive long-term returns. Behold:

Company

52-Week Return

Current Shares Short

Prior Shares Short

First Solar (NASDAQ:FSLR)

453.90%

2.864 mil

3.212 mil

II-VI (NASDAQ:IIVI)

5.25%

1.756 mil

1.783 mil

Intuitive Surgical (NASDAQ:ISRG)

203.50%

1.915 mil

2.101 mil

Sources: shortsqueeze.com, Yahoo! Finance

Still not convinced? Check out the long-term returns for First Solar, II-VI, and Intuitive Surgical. All three have throttled the S&P 500 on their way to multibagger returns. And yet all three also have a history of being targeted by short-sellers.

Small caps bite back
Therein lies the single greatest advantage of the small investor: time. By staying invested longer than others will -- certainly longer than the shorts will -- you can profit from those looking only to make a quick buck. Three to five years is an ideal time frame for Tom Gardner and Bill Mann, who together co-host Motley Fool Hidden Gems, the Fool's market-beating small-cap service.

Their reasoning? Small caps are rarely followed as closely as their larger brethren, and given time, they're more likely to be undervalued or unfairly shorted.

And remember, 10 small caps went on to become the 10 best stocks of the past decade. Via Hidden Gems, Tom and Bill are hunting for the next 10.

So let the Chicken Littles cluck all they want, Fool. You, the small investor, have no chance in this market? Poppycock.

This article was originally published on Dec. 7, 2007. It has been updated.

II-VI is an active Hidden Gems pick. Get access to the entire portfolio of stocks that Tom and Bill are recommending now with a 30-day free trial. There's no obligation to subscribe.

Fool contributor Tim Beyers didn't own shares in any of the stocks mentioned in this article at the time of publication. The Motley Fool's disclosure policy was never small time. Blue Nile and Intuitive Surgical are Rule Breakers recommendations. It just went big time.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 03, 2008, at 11:15 AM, JJ2000426 wrote:

    FSLR must be singled out from your article. It is ridiculous to call FSLR a stock with outstanding fundamentals. The fundamentals of FSLR can not be worse. The hypothetically unstoppable growth of FSLR will suddenly come to a halt, and then shrink, and then it will go out of business altogether. More over, when a stock's fundamental begin to deteriorate, most of time youc an look for problem in the management, and things could improve by replacing the management team. But the inheritant problem of FSLR is not in the management, and no management can avoid the invevitable demise of FSLR.

    It's because the extremely limited global supply of tellurium, a critical feedstock material in FSLR's raw material supply chain. Few knows about it, and no one can do anything about it.

    I am currently fully invested in PAL and SWC, the only two primary palladium producers in the whole world, and enjoying the stellar rallies in recent days. I plan to short FSLR again right before the earnings release next week. I also suggest you buy physical tellurium ingots to speculate on the fantastic price gain, guaranteed by FSLR's rapid expansion of production.

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Related Tickers

8/22/2014 3:59 PM
CALM $75.91 Down -1.29 -1.67%
Cal-Maine Foods, I… CAPS Rating: ****
IIVI $14.13 Down -0.20 -1.40%
II-VI CAPS Rating: ****
ISRG $471.74 Down -0.15 -0.03%
Intuitive Surgical CAPS Rating: ****
NILE $29.13 Up +0.41 +1.43%
Blue Nile CAPS Rating: **

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