Fool Portfolio Report
Tuesday, July 29, 1997
by Jeff Fischer (TMFJeff)
ALEXANDRIA, VA, (July 29, 1997) -- The solitary rise and fall of a foghorn, or the distant vibration of a passing train -- these things often have the feeling of "change" attached to them. Perhaps because they quietly remind a person that there's so much out there happening, always changing -- so much that you can't see.
Over a period of months people often change in such "distant" ways, too -- slowly, nearly imperceptibly. Change is what makes some people progress while others never advance past a certain plateau. Or change -- if in the wrong direction -- is a step backwards.
The change referred to before the end of this paragraph is one of opinion, and is still taking place. It isn't anything dramatic. It has nothing to do with Tom and David Gardner. It's only that I've come to feel that shorting stocks isn't Foolish. Not in general and perhaps not overall.
For several reasons, none of which have anything to do with the Fool's only short, TRUMP HOTELS (NYSE: DJT). I was onboard with that short, for what it's worth, and I still am. Trump reported a loss of fourteen cents per share today, against estimates of a positive two cents.
No. Not due to Trump.
Shorting stocks swims upstream of the Foolish philosophy by several arguments, while it fits well with Foolishness in some. In balancing the two sides against each other, though, the see-saw falls squarely -- in my opinion -- on the side that says "unFoolish."
Like the big bully in grade school when he'd jump on the see-saw and knock off the little girl.
What's unFoolish about shorting stocks? Discussing what is Foolish about shorting takes less time than considering what's unFoolish about the strategy, initially. When shorting, you're betting that a stock will go down, in the short-term usually, and that you can profit off that decline. A majority of investors don't do it. That makes it Foolish. And it's a fine way to profit in any market environment, if you choose the short well. That's Foolish.
But that second statement begs the next logical question: How do you know when you've found a stock worth shorting, and even then, how is shorting a stock superior to investing in a world-leading company for the long haul? It's very difficult for a short to beat out a long-term investment in a leading company. Very difficult. The most that you can gain on a short is 100% of the value initially shorted -- and that's only if the company goes bankrupt.
Now, The Motley Fool Investment Guide states that shorts are fun. Or can be fun. It also states that they're only for advanced investors who understand the risks, because shorts can be the most painful experience of your investment life. The risk in shorting is limitless. A stock can rise forever. Literally. You might short hoping to gain 30%, but you face endless risk in the process. The risk-to-reward ratio is horrible, and vowing to cover your short at a certain loss-level doesn't make the risk-to-reward ratio any better. It only aims to "end" the risk by surrendering to it. Meanwhile, Dell has risen 200% this year. No short has outperformed Dell. Mathematically no short has ever outperformed any stock that has gained more than 100%. No short ever will.
There are many concrete reasons to consider shorts unFoolish. But for me, investing for decades with the hopes of compounding returns, already I know that I'd rather buy Microsoft, Dell or Intel than try to short something for a slight profit, while facing endless risk.
Let's consider other reasons, though.
Foolishness is about investing long-term in stocks on the premise that the market has gained 10.8% annually since 1926. A chart of the market since that time shows a very steady climb upward. Shorting goes against that grain, against what has been the natural movement of the market, and also tries to do so in the shorter-term. Market timing can't be accomplished, though, of course. And while you can argue that a person isn't shorting the market, but is only shorting a certain stock, even company-specific timing is very difficult to do. And more important than that: How well do you know any stock that you short?
Foolishness -- aside from the Foolish Four -- is about knowing your investments as well as you can -- both inside and out. But it's much easier to measure and recognize great business models, and the risks involved, than it is to recognize a very poor business model and all the risks involved, because there are so many risks that a poor model will improve -- and improve through ways that you don't understand and couldn't have foreseen.
When you short, management is working against you, progress is working against you, and business is working against you. Business is a creature that looks for ways to grow. Sure, you can find a weak business, one that appears to be dying rather than growing, but all that needs to come along is one simple injection of life, something that you hadn't foreseen -- a new partnership, a product, additional financing -- and the business can begin to grow.
When you analyze stocks to buy, you know what management is aiming to do and you see what they have done thus far through their past performance. When analyzing stocks to short, you know what management is trying to do, but you don't know how well they can do it, since in the past they haven't been able to execute (if that's why you're considering the short). That doesn't mean that they won't execute in the future, though. That's what they're working to achieve. And you don't know how well they can execute once they begin to, because you haven't seen them do it in the past.
Look at America Online two years ago and all the resulting short sellers -- all piling on the stock as if management wasn't working on a viable technology with tremendous potential. Shorts claimed that the business model couldn't be profitable. The stock is up 500% since early 1995 and AOL is only just beginning to execute profitably under its recent and agreeable accounting method.
The America Online example brings to question the other argument for shorting, which is: "It's a good company, but I think the stock is overvalued, so I'm shorting it." Well, good Fool, how overvalued might it be? And are you sure? Good companies often execute better than expected, continually, and often sooner than expected, too. Shorting great companies, such as Coca-Cola, is like finding the most successful person in town and then following him or her around for the rest of your life, waiting for their downfall. It's a waste of time. You stand to gain much more by befriending them.
Another underpinning of Foolishness is a positive outlook on life and investing, and a belief in American business. Shorting a company doesn't foster that positive outlook or the good will that should accompany Foolishness. Hoping that a stock falls when many employees of the company have their lives tied up in the stock hardly sounds Foolish. It sounds Wise.
Is this being too sensitive? Well, if you're aiming to be Foolish, be Foolish all the way. Wish well on everyone that deserves it.
Of course no belief is absolute. I've shorted about three stocks in my life, and one was America Online last year. I made money on that short. I would have made much more, though, had I bought the stock.
I haven't shorted anything since 1996, and over the past several months I've developed the belief that, rather than short something -- taking the time to learn a bad business model and what makes a bad business, and then shorting it for whatever gains possible, but always under 100% -- I'd rather take the time to learn about good business models, and what makes good business, and then invest in those companies and let the investment ride for years to come.
The Fool has always cloaked shorting with the appropriate garment: a black robe. It's a dark horse, unusual, risky, but an interesting way to bet on a stock's fall -- a Foolish way to diversify the portfolio. But maybe it isn't so Foolish. Just maybe not, in this Fool's opinion. The message board on shorting stocks has all kinds of opinions.
What has shorting stocks done for the Fool? Since the portfolio launched, the Fool has shorted Bed Bath and Beyond, Paychex, Quarterdeck and Trump Hotels. On the three closed positions the Fool made about $454.00. Not enough to influence the portfolio's overall return. Add the Trump short, on which the Fool is currently down $2450, and overall the Fool has lost $2000 while shorting $27,000 worth of stock since inception.
Since that time -- August of 1994 -- Intel has gained 486%, and Microsoft 380%. Coca-Cola, 213%. All recognizable winners. Were the shorts that the Fool chose such recognizable losers? The best short gained the Fool a little over 20%.
Of course we can't ignore the market's performance over that time period, but we also don't try to time the market or guess where it's going. We're invested for the next decades to come, so where does shorting fit in? When should we short in this market, and when should we just buy great leaders? Personally, I'd rather buy General Electric for the next thirty years and never worry about shorting a stock again.
To close, again, Trump Hotels announced earnings that were sixteen cents below estimates, at negative fourteen cents. If Trump can't make money in the stronger summer season, winter should be interesting. Also, KLA-TENCOR (Nasdaq: KLAC) announced earnings of $0.47 after a charge, right in line with estimates. The Fool ended the day up 0.49%, trailing the S&P which rose 0.62%.
--Jeff Fischer, Fool
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Stock Change Bid ---------------- AOL - 13/16 64.38 T + 9/16 36.94 ATCT - 1/8 4.06 CHV + 5/16 78.63 DJT - 3/16 10.56 GM + 15/16 59.44 INVX --- 31.75 IOM --- 21.63 KLAC -3 1/8 60.19 LU + 1/2 83.44 MMM +1 5/16 96.56 COMS +3 58.00Day Month Year History FOOL +0.49% 8.57% 14.50% 205.58% S&P: +0.62% 6.46% 27.21% 105.56% NASDAQ: +0.56% 9.03% 21.79% 118.32% Rec'd # Security In At Now Change 8/5/94 355 AmOnline 7.27 64.38 785.49% 5/17/95 980 Iomega Cor 2.52 21.63 758.13% 10/1/96 42 LucentTech 47.62 83.44 75.23% 8/11/95 125 Chevron 50.28 78.63 56.36% 8/12/96 110 Minn M&M 65.68 96.56 47.03% 8/24/95 130 KLA-Tencor 44.71 60.19 34.61% 8/13/96 250 3Com Corp. 46.86 58.00 23.77% 6/26/97 325 Innovex 27.71 31.75 14.58% 8/12/96 280 Gen'l Moto 51.97 59.44 14.36% 8/12/96 130 AT&T 39.58 36.94 -6.67% 4/30/97 -1170 *Trump* 8.47 10.56 -24.72% 10/22/96 600 ATC Comm. 22.94 4.06 -82.29% Rec'd # Security In At Value Change 8/5/94 355 AmOnline 2581.87 22853.13 $20271.26 5/17/95 980 Iomega Cor 2594.53 21192.50 $18597.97 8/11/95 125 Chevron 6285.61 9828.13 $3542.52 8/12/96 110 Minn M&M 7224.44 10621.88 $3397.44 8/13/96 250 3Com Corp. 11714.99 14500.00 $2785.01 8/12/96 280 Gen'l Moto 14552.49 16642.50 $2090.01 8/24/95 130 KLA-Tencor 5812.49 7824.38 $2011.89 10/1/96 42 LucentTech 1999.88 3504.38 $1504.50 6/26/97 325 Innovex 9005.62 10318.75 $1313.13 8/12/96 130 AT&T 5145.11 4801.88 -$343.24 4/30/97 -1170*Trump* -9908.50 -12358.13 -$2449.63 10/22/96 600 ATC Comm. 13761.50 2437.50-$11324.00 CASH $40625.59 TOTAL $152792.47