The Perils of Shorting: A Real Life Example

[James Kirk]

I think if Tesla does make a profit some still won't be satisfied. I think that theory may soon be put to the test. Without a doubt they would have posted a Q2 profit if it wasn't for covid. Surprisingly they could still do it. With a big contribution from Gigga Shanghai Tesla could deliver 85,000 cars. If they do then a small profit is possible. That's the Q2 prediction from people who do crunch the numbers. Tight but still doable.

Well I guess that's the profit argument put to bed. Tesla will be one of the top 20 companies on the S&P shortly. Funds that track it will have to buy TSLA shares equal to it's weighting on the index. That will be a lot of shares. Tesla may need to issue extra shares just to meet demand.

 

[elacsaplau]

Well I guess that's the profit argument put to bed.....

Well, the commentary of a number of months ago that Tesla was "losing money hand over fist" was nonsense even then - as I pointed out at the time.

 

[joe sod]

@elacsaplau you successfully got a short on at the last big run up in Tesla shares at $950 in January I remember, it fell to $360 or something during the corona virus panic in March and now its at $1500, wow that is some rollercoaster, not a stock for the widows and orphans. Are you tempted to get another short on now with the recent price action?
So far you have proved all the skeptics wrong including myself, especially in how the share price recovered from March , if you bought then you would be up 4 fold. It is true that this stock has cost shorters alot of money but it must have also cost people that are long the stock and might have bought in january but panic sold in march, there had to be alot of sellers to crash the market so much in march. Tesla fell much more than the rest of the market and decoupled from the tech sector so in March it was not viewed as a tech stock like Apple or Microsoft

 

[Brendan Burgess]

Excellent article about shorting generally in The FT

Search for We are in the Golden Age of Fraud

It's an interview with Jim Chanos who shorted Enron and Wirecard.

The main message is that it's very difficult to short in a bull market.

He has two funds
One is a mixed long and short fund which has gained 22% a year over the last 35 years - double the return on the S&P

Over the same period, his short only fund has lost 2% a year.

It's a pity that the interviewer didn't pursue that a bit more.

The guy's reputation is from the dramatic shorts. But did he make his money going long?

Brendan

 

[Colm Fagan]

Brendan.
I agree it's a good article. I also agree that it's a pity the article didn't explore the reasons for the difference between the positive return of 22% a year over the last 35 years on his long-short fund (double the return on the S&P 500 over the same period) and the average loss of 2% a year on his short-only fund (also over the same period). The clear conclusion is that he made most of his money by going long.
I suspect that one of the main reasons for the poor return on his short only fund is my best friend, Tesla!!! He started shorting it 5 years ago. Since then, its price has increased six-fold (I would have thought the increase is even more!). God knows how much Tesla has cost him - even more than I've lost, I suspect!!!
His reasons for being short on Tesla?
"It burnishes its results through aggressive accounting". Agree!
"It is a culture of deception because it is selling self-driving to consumers, which as yet doesn't exist". Agree again!
I could add lots of other reasons for shorting it.
It is constantly cutting back on R&D in order to boost short-term profits, an almost certain recipe for disaster, especially in the tech business where you innovate or you die. R&D spend was down 14% in Q2 on the same period last year, it was down 20% in 2019 on the corresponding figure in 2018. In contrast, Apple, a mature tech player, spends over 10 times as much on R&D - and is ploughing more into it every year - yet its valuation as a multiple of profits is only a fraction of Tesla's.
Another good reason for shorting Tesla is Musk's dysfunctional bonus package, which includes nothing for the quality of the product or for innovation, but does reward him for diluting the interests of existing shareholders by selling additional shares in the company at inflated prices. I spent a lifetime in business and have never seen a crazier remuneration package. That's saying something, as I have seen some crazy packages over the years!

 

[Brendan Burgess]

I suspect that one of the main reasons for the poor return on his short only fund is my best friend, Tesla!!!

Hi Colm

It would be very interesting to see the return on his fund up to 5 years ago when he first started shorting Tesla.

I don't know how a short fund works. Presumably they can only allocate a maximum of [10%] to any particular stock?

It's very easy to compile a portfolio of 100 stocks to go long in.

It would be very hard to compile a list of 10 stocks to short. So they probably end up shorting stocks which are only a bit overvalued and not the massive frauds like Enron and Wirecard.

Brendan

 

[Colm Fagan]

they probably end up shorting stocks which are only a bit overvalued and not the massive frauds like Enron and Wirecard.

I recall giving some thought to this question a while back (prompted, I think, by a question on AAM from @declan11). I concluded that shorting is only worthwhile if you think the share is grossly overvalued at its current price. Given the general long-term upward trend in share prices, it doesn't work if the share is only a small bit overvalued. That does reduce the pool of possible targets considerably, although Chanos, at the end of the article, claims that this market is setting up to be one of the great short opportunities of all time!

 

[mtk]

yes FT weekend article was v interesting. I underlined a fair bit for future reference /reflection!

 

[joe sod]

@Brendan Burgess yes very true, Tesla is the text book example of why you should never short . I think the quick stock market recovery in March must have cost shorters a lot of money as well. It looked like a carbon copy of 2008 . Maybe the heightened tensions between the US and China could be the catylist to puncture Tesla, they seemed to have placed a lot of their chips on Chinese expansion and manufacturing, cars are the big pawns in the global trade wars.

 

[Colm Fagan]

Tesla is the text book example of why you should never short .

I obviously agree, based on my own experience as recounted on these pages. It's nevertheless very tempting, when all the fundamentals (low and falling R&D spend, low core profitability, excessive focus on short term profit, high turnover of senior executives, etc.) indicate that the stock will be worth only a fraction of its current price at some future date. The problem is we don't know the price trajectory between now and that unknown future date.
My latest iteration is to insert stop losses, so that portions of my short position are automatically cashed out at varying higher prices. At least I know I won't lose my shirt (again!) if the price goes even further into the stratosphere. I think a 'fair' price for the stock is around $200 to $300, so at the current price I'm running a limited risk for a large potential profit.

 

[Gordon Gekko]

Colm,

You’ve heard the one about the ‘definition of insanity’ presumably?

Gordon

 

[galway_blow_in]

Took some stones to short tesla

The only car company stock which isn't hated by Wall st ,nevermind the fact that the cars are amazing, have an unrivalled brand in terms of cool and are eating the other luxury cars lunch each year in terms of driver performance

Not saying that the stock isn't over valued, that's different

 

[Colm Fagan]

It's interesting that no-one has challenged any of my assertions on the hard realities of Tesla's business (e.g. R&D spend low and falling, Musk rewarded for diluting shareholders' interests, not being penalised for poor quality cars, pretending it has FSD when it's way behind the pack). Instead, I get ad hominem personal remarks, questioning my sanity. Enough said.

 

[demoivre]

It's interesting that no-one has challenged any of my assertions on the hard realities of Tesla's business (e.g. R&D spend low and falling, Musk rewarded for diluting shareholders' interests, not being penalised for poor quality cars, pretending it has FSD when it's way behind the pack). Instead, I get ad hominem personal remarks, questioning my sanity. Enough said.

Your're the one who lost the money.

I concluded that shorting is only worthwhile if you think the share is grossly overvalued at its current price.

That is no guarantee of success. What's to stop the share becoming even more overvalued?

Dermot Desmond couldn't understand Baltimore Technologies valuation at £50 back in 1999 and sold out. Didn't stop it from going to £130, and beyond IIRC.

 

[PGF2016]

It's nevertheless very tempting, when all the fundamentals (low and falling R&D spend, low core profitability, excessive focus on short term profit, high turnover of senior executives, etc.) indicate that the stock will be worth only a fraction of its current price at some future date.

I dislike when only one side of a story is provided to make a point. There must be a reason for the share price. Different analysts and even competitors concede that Tesla have a multi year technology advantage on the competition.

 

[declan11]

I think discussions on Telsa produce more smoke than light. Most people have an opinion and wont change their mind. It reminds me of the Roy Keane/ Mick McCarthy saga! Colm is entitled to his view and has the courage to back it up with his money. You haven't updated your investment blog recently Colm, and I would be interested in your latest ventures.
I have just come across Howard Marks of Oaktree Capital. He has been writing regular memos expressing his views on markets etc for many years and they are all available online. On reading his views of the dot com bubble written at the time, it strikes me as very similar both to the recent Tesla share price rise and of how a small number of stocks now make up a large percentage of the SP500. We know how that worked out!

 

[Colm Fagan]

I dislike when only one side of a story is provided to make a point.

I am doing my best to flush out the other side of the story, so far without success, as you can see from the exchanges above. There has been a complete lack of substantive engagement from bulls of the stock on Tesla's merits. All I got was invective.

Different analysts and even competitors concede that Tesla have a multi year technology advantage on the competition

I too have read online comments to that effect but have never seen it confirmed. What I do know is that, around this time last year, Tesla said its FSD (full self-drive) technology was making progress on stopping at stop signs and traffic lights. We were never told if it had succeeded in this modest goal. In the latest results update, Musk promised to have full self-driving by this year. The chances of that are slim to none, IMO, in the light of the cut-backs in R&D spend. Waymo is streets ahead of everyone else in FSD.

You haven't updated your investment blog recently Colm, and I would be interested in your latest ventures.

I haven't updated it, Declan, because I'm completely lost in the current market. Stocks that I think should fall in value have increased (Tesla being the classic example). There are also stocks that I thought would increase in price following Covid-19, but haven't. In the meantime, I'm hunkering down. I'll wait to provide an update until I can make sense of what's going on.

 

[DazedInPontoon]

This is at least some of the other side of the story: https://www.youtube.com/watch?v=hX6Cp4vNexc

 

[PGF2016]

I am doing my best to flush out the other side of the story, so far without success, as you can see from the exchanges above. There has been a complete lack of substantive engagement from bulls of the stock on Tesla's merits. All I got was invective.

I too have read online comments to that effect but have never seen it confirmed. What I do know is that, around this time last year, Tesla said its FSD (full self-drive) technology was making progress on stopping at stop signs and traffic lights. We were never told if it had succeeded in this modest goal. In the latest results update, Musk promised to have full self-driving by this year. The chances of that are slim to none, IMO, in the light of the cut-backs in R&D spend. Waymo is streets ahead of everyone else in FSD.

Appreciate the response. Always good to hear contrary views.

Musk is strange. Very impressive but hard to trust his pronouncements or find him likeable.

The loss of executive talent would trouble me most if I was invested in Tesla.

 

[Colm Fagan]

This is at least some of the other side of the story: https://www.youtube.com/watch?v=hX6Cp4vNexc

Thanks for that - from a fellow unfortunate Mayo person, I presume! (Pontoon?).
That's exactly the type of online comment I was thinking of. If you go through the video, there is nothing of substance in it. My main take from it was that we should forget about cars, that investors should back Tesla because it allows anyone to become a distributed utility. What on earth does that mean? How valuable is it to Tesla if we all become distributed utilities? If allowing us to become "distributed utilities" is such a wonderful business, are there any other players in this business? The capitalist system being what it is, there will be plenty of competitors in no time, who will pour money into R&D. Meanwhile, Tesla will fall behind, because it is skimping on R&D, in order to show a quarterly profit. In the tech business, you innovate or you die. Tesla is no longer innovating, ergo .....