The long and short of it

The long and short of it

Why do most of my articles have a negative bias? Am I an evil short-seller conspiring against honest fair dinkum Aussie companies (and investors)? For what it’s worth, I will try to convince you here why I am not.

The negative bias can be quite simply explained – I only write when I believe I can contribute insights of value to the “conversation“.

Typically, listed companies will ensure that the investment community is well aware of all its positive attributes – with advisors, brokers, analysts and commentators amplifying these from the sidelines. There’s simply very little value in me parroting it to my readers.

As a participant in the system, there is typically a positive correlation between your economic rewards and financial valuations. When the pie is getting bigger everybody can skim off a slice, whether that be brokerage commissions, underwriting fees, advisory fees or performance fees. This is a happy place for everybody.

On the other hand, when financial valuations are decreasing, the pie gets smaller for everybody and it’s not a happy place to be for all involved. As a participant in the system you do not want to be associated with this unhappy place.

Consequently almost all participants will have an economic disincentive to call bullshit on things.

Never short with your grandmother’s savings

The mathematics of shorting a stock is extremely unfavourable to an average investor. It represents exactly the wrong type of asymmetric returns – i.e. you’re risking an infinite amount of capital for fixed returns while at the same time being subject to the upwards secular tailwind of the stock market.

And it’s simply dangerous to assume that whatever is behind the irrational exuberance won’t continue indefinitely into the future. Fast increasing earnings (whether illusory or not) together with sentiment-driven multiple expansion can quickly devour unsuspecting punters.

Assume you’re to retreat into a cave for the next 10 years. You could sleep quite well at night with a basket of long positions in randomly selected companies. On the other hand, could you sleep well at night with a basket of short positions in randomly selected companies? (in fact the most likely outcome in the latter scenario is that you re-emerge from the cave with nil or negative equity).

How short-oriented research is valuable to long investors

Contrary to what many believe, most of the time I hold no positions at all in companies where I espouse negative or critical opinions. My financial gains from the analysis have predominantly come in the form of loss avoidance.

During 2016, we avoided losses stemming from the risks that Surfstitch’s revenue growth may be largely illusory, that Intueri’s “online business” was highly suspect, that iSentia could trip up searching for growth outside of its legacy moat, that Amaysim’s gross profit margin was unlikely to be sustainable and that Residential Aged Care providers could get into trouble with their aggressive capital structures.

To be clear, these were simply risks that were identified. There was no certainty any of this was going to play out, let alone play out within such a short time frame. However, only when you identify your risks can you properly control and manage your risks.

If you don’t lose money, most of the remaining alternatives are good ones.

Thanks for reading as always. I hope to continue to contribute to the “conversation” over 2017.

Please reply below with any comments (or you can contact me privately).

Note: The above article constitutes the author’s personal views only and is not to be construed as investment advice in any shape or form. Please do your own research and seek your own advice from a qualified financial advisor. Being obviously passionate about the art of investing, the author may from time to time hold positions in the aforementioned stocks consistent with the views and opinions expressed in this article.