It's a sad fact of life that the notion of decorum in this country is about as relevant as whale oil lamps and buggy whips. Nowhere is that more true than in investing -- a world fueled by testosterone, stress, and money.
With seemingly everyone now turning to naked shorting and "manipulation" as the excuse du jour (remember the good old days when we just blamed everything on the Arabs, Japanese, or program traders?), it can be tough to be a short seller.
If you don't believe me, just take a quick look at how shorts are treated on the message boards for companies like Apple Computer (NASDAQ:AAPL) or Lexar Media (NASDAQ:LEXR). Heck, even my fine and upstanding colleague Seth Jayson has been called just about every vile name in the book for daring to challenge some of the fuzzy logic that has fueled stock runs in some pretty questionable names.
Even in my own experience, when I've dared to question the likes of Doral (NYSE:DRL), Ballard Power (NASDAQ:BLDP), or Axonyx (NASDAQ:AXYX), there's been a reliable stream of nasty email in my inbox. Never mind that I was dead-right on two of those and the jury's still out on the third.
This is all too bad, because in their rush to shout down any opposition, a lot of these "informed investors" are acting like complete idiots.
The whole reason I'm writing this today is because of a long series of chats I've had with a friend of mine who just so happens to be a hedge fund analyst. We've been talking for some time now about a company that I happen to know fairly well and that he thinks is a great short. And here's full disclosure for you conspiracy buffs -- I don't have any financial interest in the company in question, I've never written about it, and I probably never will.
I wish the average investor could take a look inside the decision-making process and see how much work a lot of professional investors put in before finally pulling the trigger on a short sale. In fact, I'd go so far as to say that those who routinely short stocks generally do more (and better) work than those who just play the long side of the equation.
My friend has asked questions that I'd never even thought of, and he's pored over the company's financial statements with a fine-toothed comb -- and found some interesting discrepancies that suggest something smells bad.
This friend of mine isn't the only one. When I was a Wall Street analyst, many of the most intuitive questions I ever got were from hedge fund analysts sniffing around for short ideas. What's more, on the occasions when I got a peek at their models, I saw a level of detail and insight that would put most sell-siders to shame.
Now, if my friend were to write for The Motley Fool or post his discoveries on message boards, would his diligent research be respected? Of course not. He'd be shouted down amidst slander and profanity, and he would no doubt be accused of being a "manipulator" if the stock subsequently went down.
Instead of benefiting from someone else's hard work, and perhaps saving themselves from a sharp decline in their own portfolio, they would just dismiss him out of hand and throw his insights on the scrap heap.
One of the most common, and worst-thought-out, attacks on short sellers is that they're all trying to do something illegal. Although there is no doubt that some people commit legal and/or ethical abuses in shorting -- whether through illegal acts like deliberate naked shorting or blatant attempts at spreading false information -- that's no less true for those who play the long side. Frankly, I'd argue that fraud that overinflates a company (in the case of Enron, for example) is usually far more damaging to investors as a whole.
What's more, nothing is more dangerous than shorting a stock that shouldn't be shorted. The market seems to have a "natural buoyancy" that biases stocks to go up over the long haul, and there are always many more investors willing to go long than short. Even worse, the Wall Street research industry and business media is oriented to talk stocks up, not down. So while you can almost always be sure that a company's success will be celebrated, you won't often hear about disasters in the making until they've blown up and it's too late to get to a safe distance.
Going further, those who wish to short have to abide by a series of rules -- they have to wait for upticks, they can only short (legally) if they can find shares available, and they have to pay any dividends that come through while they're short. That's a lot of hassle to go through when you could just put in a "buy" order on some other stock.
Investors would do well to remind themselves of one essential fact -- professional investors, be they long or short specialists, are in the game to make money. They're not "playing the market" because they are ego freaks or because they're trying to overcompensate for deficiencies in their lives. They're doing it because, by and large, they're smart, they're good, and they love the challenge.
At the end of the day, the stock market is a highly efficient means of assigning value to companies based upon the quality of their businesses and their growth prospects. It's no mystery that stocks like Coca-Cola, Abbott Labs, and General Electric (NYSE:GE) have done so well over time; they have consistently delivered the goods in terms of cash flow and earnings.
What's more, no short seller can really interfere with that. Whether you are long a stock or short, you don't have any real impact on the day-to-day business. A company with a fatally flawed business plan (whether it's Eastern Air Lines or Commerce One) is going to fail, whether there are millions of shares sold short or not a single share sold short. Likewise, all the shorts in the world couldn't have stopped Cisco Systems or Microsoft from succeeding.
Even if you want to take the most extreme example possible -- say, that shorts could push a development-stage company's stock so low that it couldn't get proper financing -- the private investment market is always on the lookout for intriguing investment possibilities. Simply put, given that venture capitalists and merchant banks are perpetually short of good ideas, it's pretty safe to say that no good idea goes unfunded.
I'm not so naive as to think that anyone prone to shouting down opposing viewpoints is going to change just because of what I've written. But for the rest of those sane investors out there, perhaps they should make an effort to appreciate what shorting is really all about.
At its essence, shorting is about finding companies that are more like the "great and powerful Oz" than the future royalty of Wall Street. So the next time you hear somebody say that the emperor has no clothes, maybe you should actually listen to his or her case and take a second look of your own. After all, if it helps you avoid the next Enron or Commerce One, isn't that worth your time?
For more thoughts on shorting, try these other Foolish opinions:
- Who's Behind Naked Shorting?
- Where Money Goes When Stocks Fall
- My So-Called Journalism
- Putting Blame Where It Is Due
Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
