Friday, March 4, 2011

Taulli, All About Short Selling

All About Short Selling: The Easy Way to Get Started by Tom Taulli is the twenty-first title in McGraw-Hill’s “All About” series. Despite the subtitle, the book demonstrates that there is no easy way to get started—or at least no easy way to zero in on winning opportunities. Investors need not go to the extremes of Bill Ackman, who analyzed some 140,000 pages of documents prior to shorting MBIA. Nonetheless, the author acknowledges, “the best short sellers use painstaking research and analysis.” (p. 37)

Taulli adopts a three-pronged approach to analyzing potential shorts. First is fundamental analysis, by which he means looking for opportunities among fads, disruptive activity by new competitors, the transition to commoditization, and failed business models. Consider, for instance, the hit that Blockbuster took when NetFlix became a significant player in the video and DVD market. Or the impact on GPS companies such as Garmin and TomTom when Google developed its own free GPS platform.

Second is accounting, which involves among other things the analysis of a company’s balance sheet, income statement, and cash flows. This is an area where many successful short sellers focus their attention. Admittedly, accounting is complex and often nuanced; even highly reputable companies massage their numbers to paint the most flattering portrait legally possible. And although Taulli spends four chapters on accounting issues, he only scratches the surface of what a savvy short seller would need to know.

Third is technical analysis, which is used not to find viable candidates but to determine entry and exit points in individual positions and to assess general market conditions.
Although many investors limit themselves to the stock market, Taulli looks at alternative techniques, normally requiring less margin, to express a negative hypothesis. For instance, one can short with options, futures, mutual funds, hedge funds, and ETFs. He concludes his survey with a chapter on risk management.

There is a lot of information in this book. For instance, Taulli introduces the reader to the potential pitfalls of spin-offs and tracking stocks. He discusses the multiple manifestations of arbitrage—stat arb, merger arbitrage, and convertible arbitrage. And he explains the complications of a market-neutral portfolio.

A rank beginner would be overwhelmed by this book, but then a rank beginner should never be a short seller. For the investor with some experience, All About Short Selling provides both a good introduction and most likely a long to-do list.

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