Book Summary: Short Selling

Book: Short Selling

Author: Amit Kumar

Key takeaways:

Short selling is hard. If you are a short seller, by the very nature of what you’re trying to do is seeking the type of information that is not easily available, not widely distributed, and certainly not in-line with the consensus. Short ideas naturally need more time to reach conviction (vs. longs) because the information is harder to come by.

Furthermore, because timeline for shorts is not long, for the trade to work, we need a catalyst. More often than not, the catalyst is a change in investor psychology, which is triggered by a number of factors such as a sales miss/earnings miss/accounting problems/competitive change.

The good thing about short ideas is that it can be recycled because of turnover in investor base where the new investors haven’t learned the lessons that the old investors have learned.

According to Kumar, there are 3 types of shorts –

  • Structural Shorts: 1-2 year outlook
    • Unsustainable Leveraged Business Model
      • possibility of covenant breach, credit rating downgrade
      • heavy dependency on financing / tightening credit cycle
    • Business Model Issues
    • Value Traps: Stocks that appear cheap on certain metrics, but (a) may not have moats to protect them in a changing business, and (b) may face long-term chronic issues
    • Broken Growth stories
    • Financial Statement issues
      • Have they changed any assumptions on how revenue is recognized etc?
  • Tactical Shorts: Up to a Q outlook
    • Signs of macroeconomic issues / recession (very very hard to call)
    • Successful investor announces a short position
    • IPO lockup expiring, key investors exiting, insiders selling
  • Paired Shorts

 

Very important, below are some of the key types of shorts not to get involved in

  • High Valuation: even companies trading at 10-20x sales are risky because often the business models and markets are very open-ended and are hard to gauge.
  • High sales growth: Somewhat related to the point above, companies with a long runway of sales growth
  • Star CEOs: unless there is a significant miss, market will always take the CEO’s word vs. shorts’ (see TSLA)

Troubled companies that are being shorted, by definition, seem to attract more speculators and M&A rumors, so don’t get too rattled by these rumors.

 

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