Article by Investment Master Class

“He who sells what isn’t his’n must make it good or go to prison.” The amateur speculator soon learns this little Wall Street jingle and is often deterred by it from making a short sale.  It is essential, however that he understand the mechanics of short selling, its economic function and perhaps the ethics, if any, of such a transaction” Philip Carret 1930

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“We do short individual equities from time to time, but we short with respect, experience, and proper sizing and stop-loss levels”  Kyle Bass

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“For the most part, we avoided the damage in the short portfolio [in the tech bubble] by refusing to sell short anything just because its valuation appeared silly. We reasoned that twice a silly valuation is not twice as silly. It is still just silly. Kind of like twice infinity is still infinity”  David Einhorn

“If I ask someone who runs a long/short equity fund who is 20% long and 20% short, if they’re levered, the most likely answer would be no. In reality, if you’re short anything you’re levered, because if it “Volkswagens” you, you’re going to lose all your money”  Kyle Bass

“While we love catalysts on the long side, we require them on the short side. Valuation shorts are always tricky”  Shawn Kravetz

"A basic principle in going short is that there has to be a catalyst" Steve Cohen

"When I first started to put out sell-side research in the early 1980's, I believed that going short was simply the mirror image of going long.  I assumed that all the attributes used on the long side could be reversed on the short side.  I no longer believe that". Jim Chanos

"Many of my shorts over the years have been management teams that are repeat offenders. Some of these guys, no matter where they go, hype whatever the current product, idea, concept or whatever flavor of the day people want to hear."  Marc Cohodes

“You have to remember that if you are shorting a leveraged company, with 90% of the capitalization in debt and 10% in equity, a 50% decline in the stock only wipes out 5% of the total capitalization. You have to look at the total capitalization”  Jim Chanos

"We’re looking for companies [to short] with weakening moats, often coupled with a resulting deployment of capital into areas in which they have no competitive advantage. Even better is when they’re deploying not just excess capital, but leveraging the balance sheet to do so”  James Chrichton

"The goal should be that in the middle of a storm that puts all the less-seaworthy boats at the bottom of the ocean, your boat, battered as it may be, makes it back to shore. Short selling helps you do that." Zeke Ashton

“Our favourite short opportunities are companies that are highly leveraged, need access to capital to survive, require substantial management judgement in the determination of their reported earnings, and have fundamentally bad business models. For equity shorts, we have an additional criterion that there is a “ceiling on valuation”. A ceiling on valuation is what we deem to be the equivalent of a margin of safety for long investments. In other words, we look for equity shorts where the conventional bounds of valuation for a particular business protect us from material stock price increases”  Bill Ackman

“One painful lesson on the short side has been that mere absurd overvaluation is not sufficient reason to be short”  Whitney Tilson

"We do not generally engage in the short sale of overvalued securities, believing that short-selling could effectively increase, not decrease, portfolio risk in certain kinds of markets"  Seth Klarman


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"Shorting great companies on valuation is a formula for going broke" Shad Rowe

“Investors often become emotionally attached to companies in which they’ve made a lot of money, so I’ve found that in the first year or so after a company starts to make excuses for falling short of its historical success, the market reacts in a very benign way. That can give us an opportunity, if we believe the situation has fundamentally changed, to make attractive bets on the short side”  Brian Zied

"If you're interested in shorting stocks, it's very labor intensive. You probably have to do 6x the work that the longs do. You have to have the courage and faith in your work. I used to say, 96% of the time, you go home feeling and thinking like you're an idiot, and you get paid 4% of the time. So when you have a good day, you have a great day. But your bad days are numerous. It takes a certain mind and mindset to be able to deal with that. Most people just can't." Marc Cohodes

“Part of it is the fear in the back of every manager’s head that stocks can go up infinitely but you can only make 100 percent on the short side; stocks can only go to zero. My reply to that has always been: I have seen more stocks go to zero than infinity”  Jim Chanos

“I believe the internet bubble made its ultimate top the last day the last short seller could no longer afford to hold his position and was forced to cover. Market extremes occur when it becomes too expensive in the short term to hold for the long term”  David Einhorn

"A few thoughts should be kept uppermost in mind. One is: never sell a stock, because it seems high priced. You may watch the stock go from 10 to 50 and decide that it is selling at too high a level. That is the time to determine what is to prevent it from starting at 50 and going to 150 under favourable earnings conditions and good corporate management. Many have lost their capital funds by selling a stock short after a long upward movement, when it "seemed too high"   Jesse Livermore

“I need to have conviction in all my shorts about either a company specific catalyst or a macro catalyst”  Whitney Tilson

"Any company with a management team that focuses on, mentions, is bothered by, or attempts to squeeze short sellers, is almost definitely a short." Marc Cohodes

"Shorting is not a criminal trial. It doesn't have to be beyond a reasonable doubt. There just has to be a preponderance of evidence" Jim Chanos

"With our shorts we're even more focussed on catalysts and we've found our performance has improved since we created an entirely seperate investment process around them" Richard Vogel

"Shorting stocks to me is like a cattle drive, I am confident that I will be right and make money, but in getting the cows from Omaha  to Fort Worth, I will probably end up with some arrows in my ass. I just want to make sure they are not in my back. So that means you can be dead right on the fundamentals, but if your timing is wrong, you are wrong and better adjust. That took me a while to learn, but it’s important." Marc Cohodes

"As long as no-one cares about it, there is no trend. Would you short Nasdaq in 1999? You can't be short just because you think fundamentally something is overpriced. You can wait until people start to care. So you are selling the market on the way down not the way up"  Colm O'Shea

"In general, on the short side we focus on poor fundamental and competitive situations, hopefully with weak management teams, more than we focus on valuation. In other words, we have no problem shorting cheap stocks where we see long-term structural or competitive problems. And we never short stocks purely for valuation reasons. As we have all seen over the last year, unreasonable valuation can often become more unreasonable" Lee Ainslie

“Valuation itself is probably the last thing we factor into our decision.  Some of our very best shorts have been cheap or value stocks.  We look more at the businsss to see if there is something structurally wrong or about to go wrong, and enter the valuation last”  Jim Chanos

“In most walks of life the early bird undoubtedly gets the worm, but in selling short it is mostly the tardy sellers who succeed”  Gerald Loeb

"We do not short to hedge.  If we are uncomfortable with the risk in the position, we simply reduce or eliminate it.  By having a portfolio of worthwhile longs and worthwhile shorts, we achieve a partial market hedge without having to spend capital on negative-expected-return propositions"  David Einhorn

"Our short exposure is achieved by shorting individual stocks, which I think is increasingly unusual these days. But to us, it’s critical, because we want to add value on both the long side and the short side. If you use market-related indexes to create your short exposure, by definition it’s not going to add value."  Lee Ainslie

"We don’t short in order to call ourselves a hedge fund, but when we think we can make money at it"  Leon Cooperman

“A stock should never be sold short because its price looks too high”  W O’Neil

"Catalysts are a higher priority for shorts because time is generally not on our side given that the market goes up longer term.  Occasionally we will short on valuation without a specific catalyst, but that can be risky because an excessive valuation can easily become more excessive.  In those cases there are two things we like to do to mitigate our risk.  First we generally make the position sizes smaller.  Second we try to use the law of large numbers to our advantage.  For example, if we're anticipating that a glamour stock's revenue growth will mean revert, it's easier to do that with a company that has billions of dollars in sales facing natural deceleration.  Also from a maker cap standpoint, its a lot harder for a company with a $45b market cap to double than it is for a company with a $45m market cap."  Rolf Heitmeyer

"A key problem for investors who short a company that is subject to government oversight is that the government, even when it acts, does not move at the speed of the stock market.  Two years might make a prompt government investigation, but it is an eternity for investors such as Greenlight reporting monthly results, even in a long term strategy"   David Einhorn

"I prefer situations in which I can have five shooters on the target rather than one. For example .. I think I can win on a bubble, on fraud, on lack of reserves, on the macroeconomics, on money laundering. There's a zillion ways I can win." Marc Cohodes

“For my shorts, I look for a bad management team, and a wildly overvalued company in an industry that is declining or misunderstood” Julian Robertson

"While on the long side we're concentrated with a one or two year time horizon, on the short side we're diversified with a time horizon of two weeks to two months"  Alex Roepers

"When we’re short, we look for deteriorating industry conditions, company-specific fundamentals at risk and liquidity issues. We will short a good company, even a cheap company, if we think reality will fall short of current expectations. The best way I’ve learned to short is by making mistakes on the long side – in value traps, for example – and then recognizing when others are making the same mistake." Larry Robbins

"Because there are more ways to get hurt on shorts than longs, we typically keep the position sizes smaller and pay even more attention to liquidity and how crowded the trade is.  There's no worse feeling than being stuck in a short as it's going up"  Curtis Macnguyen

"Our view is that short selling may not in most years be worth the time and effort you spend on it, but you do it precisely for those years like 2008 when shorting not only offsets losses on your longs, but also produces capital that allows you to average down on the long side."  Zeke Ashton

"I think making money on the long side is a more fruitful activity, but from a portfolio-management standpoint, the shorts give you the staying power to live through difficult market conditions.  In a perfect world, you should be able to make money on both your longs and your shorts in the long run" Dan Loeb

"You don't see any Fifth Avenue mansions built by bears" James R Keene [from Bernard Baruch's 'My Own Story]

"One important thing to understand is that there are many easier ways to make a living than shorting stocks. If you want to make a lot of money on Wall Street, shorting stocks is not what you want to do."  Marc Cohodes

"As an equity trader, I learned the short-selling lessons relatively early.  There is no high for a concept stock.  It is always better to be long before they have already moved a lot than to try to figure out where to go short"  Joe Vidich

"In shorting it's much harder to underwrite your downside which is something crucial to keep in mind" Ed Bosek

"People make trades without a good reason.  They step in front of freight trains.  They short stocks because they are up, as if that were a reason.  They'll say "I can't believe the stock is so high," and that's their total research.  That makes no sense to me.  My response is: "You have to do better than that'" Steve Cohen

"If I make you a few percent a year being short, in effect I'm an insurance policy.  I'm protecting your downside and I'm paying you a small amount in dividends.  But think about it.  You could then go twice long the market, be short my portfolio, and have 2X the market plus a few percent, minus your cost of the additional carry.  And that's the proposition, and that's why short selling alpha is so prized in the marketplace when you can find it, because it enables you to be more long.   As I keep saying to people: I'm in the insurance business" Jim Chanos

"It’s difficult to have hard and fast rules. When you short stocks, you get involved on a carnival ride that's called 'anything goes,' which includes buy-ins, manipulations, fake tenders, and all sorts of shenanigans which can cause stocks to gyrate in a crazy fashion.   Before I short anything, I have a few protections. First, I always assume the short can double on me. I size the position accordingly. Second, I guard against "thesis creep." If the thesis changes, you better get the hell out. If you don’t, you'll clearly get buried. As long as your thesis is pretty good and your analysis is right, you can hang in there. Third, I never, ever, ever get involved in what I would call open- ended situations. I've never been short a drug company that can theoretically solve a big problem. I have avoided pie-in-the-sky names. To use an analogy, I’m not interested in climbing into a tree and wrestling the jaguar out of the tree. I'm interested in someone shooting the jaguar out of the tree, and then I will go cut the thing apart once it hits the ground. Instead of open-ended situations, I like to short complete pieces of garbage with fraudulent management and horrifically bad balance sheets. I look for change, I look for "if this goes away tomorrow will anyone miss them"? What do they do well? " Marc Cohodes

"In most successful short sales, we lose money gradually for a period of time until we suddenly make a large gain - often in a single day"  David Einhorn

"I normally lose [on shorts] first then hopefully win.  I do look for breaks in the fundamentals first before I dive in. When the market begins to care is anyone’s guess." Marc Cohodes

"Timing is delicate, sometimes exquisitely so.  To go short on the right stock at the wrong time (on the way up) may be horrendously expensive.  Ask those who went short Litton, TelePrompTer, Levitz Furniture, Memorex, and many others - rightly but too soon.  I knew a man who lost everything selling short in the summer of 1929, at the height of the bull market.  He didn't have the reserves to hold out until autumn"  Roy Neuberger

"When they first went public I noticed the top two guys in management wore wigs.   I am 10/10 in shorting guys who wear wigs. It’s another indicator of mine.  I don’t know what it is with guys who wear wigs but they make great shorts." Marc Cohodes

"Over the years, we have uncovered many of our best short opportunities in mundane and competitive businesses that have experienced a significant increase in their valuations following an unsustainable increase in margins and earnings."  Anthony Bozza

"Ideally I would like to go short companies that are expensive relative to their sector and where I expect profit warnings over the next few years.  The problem is that these bad companies have the greatest risk of being takeover targets... You can be long a good stock at 7 times earnings and short a bad stock at 15 times earnings, and some stupid foreign company comes along and pays a 50 precent premium to buy the bad company"  Martin Taylor

“Be very wary of a company that shows two things .. lots to management stock sales from different people, but more importantly management departures, if you are seeing a company when 10 or 15 or 20 people are leaving within a year or two.. look out”  Jim Chanos

“When I sell something short I am not trying to create a hedge, I am trying to create a profit.  We do this by identifying stocks that are both overvalued and deteriorating.   In many cases there is something wrong that we have unearthed that is not widely understood in the market”  David Einhorn

"The two best indicators of a company on its way to bankruptcy - rapidly shrinking revenues and a quickly rising debt level" Scott Fearon

"In the world of shorts, you're fighting dividends and borrowing costs.  Therefore the bar is higher to justify our shorts, as we have to overcome these costs"  Neal Nathani

“One of the models we look at is a wonderful checklist by Marianne Jennings, it’s from a book called ‘The Seven Signs of Ethical Collapse’.  I will tell you at both Valeant and Enron, the CEO’s and the situation fit about 6 or 7 of them.   One of them is ‘Innovation like no other’, another is ‘Larger than life CEO’s and a compliant board’.  Another one is ‘Good works in one area tries to atone for evil in another’.  There’s a number of companies we are short now that fit that checklist almost perfectly.  We keep an eye on these kinds of things.  When you get bad governance and messianic leadership, you have trouble on your hands”  Jim Chanos

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