Wednesday, December 16, 2015
Kumar, Short Selling
Short selling is notoriously difficult. Kumar doesn’t recommend it for the average individual investor; “it is geared more toward institutional investors with sophisticated research and risk management resources.” (p. 218) But even they can go badly astray. Keurig Green Mountain, for instance, looked to many like a promising short until, boom, it got an insanely generous buyout offer and the stock skyrocketed 72% in a single day.
Kumar helps investors navigate the treacherous waters of short selling, introducing them to the kind of research necessary to come up with potential targets and illustrating his points with case studies. In 2010 Office Depot was a classic case. As Kumar writes, “It is hard to find shorts with as many negative catalysts as Office Depot: losing market share, structural issues with business model, high debt levels, share dilution, and poorly aligned management incentives.” (p. 50)
For this book Kumar interviewed value investor Jean-Marie Eveillard , activist investor Bill Ackman, and researcher Mark Roberts. In response to the question of whether it is inherently more difficult to generate alpha on shorts than longs, Ackman said: “It is harder and creates more brain damage than you can imagine. Will we do it again? … We waited five years after closing the MBIA short investment before we built our Herbalife position. We may wait another five, ten, or twenty years to do the next one. Who knows, we may never get involved in shorts in the future. If and when Herbalife plays out the way we expect, perhaps the next time we will just say the name of the company without taking a short position and wait for it to go to zero.” (p. 149) Ackman’s frustration is palpable in these sentences.
Kumar’s analyses are worth studying, even if one is a long-only investor. He explains how to expose chinks in the armor of companies. And he also shows how, through an analysis of a potential short, the investor can flip and make an informed decision to go long. His analysis of Netflix in 2012 is a case in point.
Investors who buy stocks should subject the underlying company to a stress test: what, given the company’s financials, its management, its position in the market, could go wrong? It is even more critical for investors looking to short stocks to subject their thesis to an analysis of what could go right with the stock (and hence wrong with their position). Kumar provides investors with an excellent guide to engaging thoughtfully and rigorously in the debate over whether or not to go short.