Carl Icahn is famous on Wall Street for taking big positions in companies in an effort to influence the business decisions their management teams make. In a bit of a twist, short-seller Hindenburg Research targeted Icahn's public company, Icahn Enterprises (IEP -0.12%). This episode provides some light on what investors should do when short sellers pop up.
What is short selling?
Essentially, a short seller is looking to benefit from a drop in a stock's price. There are any number of reasons for expecting a stock's price to fall, from an extremely high valuation to company-specific issues that are expected to result in poor stock performance. In its most basic form, a short sale involves borrowing stock from a broker and selling it in the hope that it can be repurchased at a lower price later and returned to the broker. The profit is the difference between the sale price and the purchase price.
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This is not a simple way to make money, and most investors should probably stick to buying for the long term. Active investors and professionals are the ones who frequently use this approach. It's important to note that the profit potential is limited to the stock price decline (which can only go to zero), while buying and holding can lead to unlimited upside potential.
What's more interesting for individual investors is the fact that short sellers often put out research on the stocks they are targeting. The goal is to convince other investors to sell the shares, thus helping the short seller to make a profit by depressing the stock's price further. So you need to take such reports with a grain of salt.
Still, these reports can provide a valuable counterpoint to your own purchase thesis, which is most likely a positive one. And if you are like most humans, you will tend to spend more time focused on information that supports your view than information that refutes it. Thus the negatives of a short report can help you think more deeply about your investment decision.
Carl Icahn gets targeted
Carl Icahn is best known for trying to influence management teams via large ownership stakes in their companies. One of his investment vehicles is Icahn Enterprises, a public company. Recently, the prominent short-seller Hindenburg Research took aim at Icahn Enterprises, effectively turning the hunter into the hunted.
Hindenburg's thesis rests on a number of factors, including material inside ownership by Icahn and his family, a lofty valuation, and weak performance of the company's recent investments. Also, Icahn Enterprises paid a very large dividend that Hindenburg didn't feel was justified by the company's performance. That's a quick summary of a very large report.
However, if you own Icahn Enterprises it would be a good idea to do a deep dive on this report. You probably consider the connection with Carl Icahn important, and perhaps his historical success has led you to place a premium on his involvement that is no longer justified. And since Icahn and his family own a huge stake in Icahn Enterprises, that big dividend was basically Icahn paying himself. That's a potentially worrying proposition. Taking a second look at such things is probably a valuable use of your time.
The normal course of events here is that a short seller complains about stuff and the target company defends itself. And that's exactly what happened this time around. However, Icahn Enterprises did end up cutting its dividend in half, which resulted in a steep stock price decline. So, in some ways, Hindenburg appears to have won this fight -- for now.
Indeed, in his defense of the company, Carl Icahn stressed that his activism is focused on long-term results. It can take years for one of his investments to play out, whereas Hindenburg was focused more on short-term factors. Only time will tell who is correct here over the long term, but it seems clear given the dividend cut that Hindenburg's criticism was reasonable in the near term.
You'll want to understand why
You may completely disagree with Hindenburg about Icahn Enterprises and think that the company's long-term approach is spot on. That's perfectly fine, but short-seller research challenging that view is worth reading and digesting. You might decide to do nothing, or you might change your view. But you'll never know where you fall on the issues being raised unless you take the time to think about them more deeply. That's the biggest benefit you'll likely derive from short sellers.
