The Perils of Shorting: A Real Life Example

Well Colm, you can't be saying your posts are not generating responses on this thread. I have nothing intelligent to add to the financial debate but I wonder did Musk deliberately plan to break those windows. He has got major media exposure from it anyway!
 
declan11 said:
I wonder did Musk deliberately plan to break those windows. He has got major media exposure from it anyway!
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Hi Declan. "All publicity is good publicity”? Interesting thought, but I doubt it. He looked stupid making a sales pitch in front of two shattered windows. I wonder if the whole thing was a sham, since I can't see how a truck with reinforced steel on the outside could ever see the light of day. It won't get regulatory approval. God help the poor pedestrian that got hit by one of them.

While I'm on to you, Declan, I gave an overly simplistic, even trite, answer to your earlier question (#8 in this thread, my answer #11) on why I short shares when the expectation is that they'll deliver positive real returns in the long-term. Sorry.

I've been thinking about it since, and the reality is much more complicated than what I wrote about buying if a share is trading at less than its fundamental value (in my opinion, of course) and selling if it's trading at more than its fundamental value, where the "sell" decision can mean shorting if I don't have the share already.

My more considered answer is that there is a threshold for selling shares. If I have shares in company A that I think are trading above their fundamental value, I don't normally sell, for the reason you outlined, i.e. they should eventually "grow into" their market value. If I've identified another Company B that I think will perform much better than A and if I don't have any other source of funds, then I will consider selling A to fund the purchase. That calculation (often done implicitly rather than explicitly) must allow for the costs of selling A and buying B (including CGT etc.) The example I quoted last month illustrates that thinking in action. (You can find it elsewhere on this forum or on my website www.colmfagan.ie)

There is a higher threshold again for shorting a company's shares. I must believe strongly that, not only will it under-perform the market, but it will deliver a negative nominal return over the next (say) two years or less, and that I can fund the margin requirements if the price goes mad in the meantime. That's a very high bar. I'm also loath to short a company that's paying (or is likely to pay) a dividend, because you have to fund dividend payments as well as the (albeit low) borrowing costs for the shares themselves. It's also extremely dangerous to short a company that could be taken over at a premium to the current market price. Neither of the last two considerations applies in Tesla's case.

A final word of caution is that, in the words of theatre magicians, shorting is definitely NOT a trick to be tried at home without considerable (limited risk) practice. You could lose your shirt - and much more - in the blink of an eye.
 
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The problem to me is there is more to the share price than the balance sheet , I don't know much about Tesla but maybe there is a belief that this it's just a matter of time before Tesla breakthrough and become huge and there's a Tesla in every driveway.
The market can easily stay irrational for a long time it's more than just the total number of shares * share price to value a company .

If it was as simple as company values then the smart people would short all the investment trusts trading above NAV and sit back and clean up , how do you account for investment trusts trading above NAV for years on end , we can see they are over valued in the true value sense but some of these continue to stay above NAV for prolonged periods and then the share price rises and the NAV continues to rise above that. Is it not fair to say that people belief in Elon Musk and the value he potentially will bring to the company will keep it inflated indefinitely until the time it is actually a very valuable company both in financials and sentiment ?
 
Fella said:
The market can easily stay irrational for a long time it's more than just the total number of shares * share price to value a company .
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Hi Fella

That is a key point.

And it means that you should only allocate as much of your total portfolio so that you can sit it out for a very long time or handle a big increase in the share price and be prepared to lose your allocation.

There are a few potential outcomes to Tesla and other "obviously" overvalued shares
1) The share price can fall to their correct value
2) They can remain overvalued indefinitely
3) Their value can rise to match their share price

Bitcoin has no value, so its price must fall at some stage to zero. Having said that, it has remained irrationally valued for much longer than I expected.
Tesla - I just don't know. It is worth something, but I have no idea what. I would expect that Colm is correct and that it is way overvalued , but there could be some breakthrough so that situation 3) happens.

Brendan
 
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I suppose where I disagree with colm on Tesla is I don't think that Colm can know more than the markets .I believe that any functional market with enough action on both sides will find it's equilibrium at a fair value , the value may not make sense financially but there will be people with in-depth knowledge of Tesla and the future and what is coming down the line , and Colm is not one of them .
He is taking a big risk , Telsa could announce any breakthrough in technology and he could face a huge loss on a gamble , he could also make a huge gain , but it's also a gamble .
 
Fella said:
Telsa could announce any breakthrough in technology and he could face a huge loss on a gamble
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It's more of an investment decision than a gamble.

And it's one of a portfolio of investments.

If he has a limit on his loss, then that is fine.

Brendan
 
Brendan Burgess said:
It's more of an investment decision than a gamble.

And it's one of a portfolio of investments.

If he has a limit on his loss, then that is fine.

Brendan
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Well I would say it's a gamble
When you log into your stock broker account do you get a warning saying 70% of people lose money investing ? I think not
When you long into your IG index you get such a warning .
Shorting is a gamble and the outcome is chance , it is no difference than going to a roulette wheel in my opinion , you cannot predict short term movements.
Investing in stocks long term has a positive expected return , shorting doesn't .
 
I agree with a definition of gambling which says it is chasing a win whilst accepting a negative expectation (in the mathematical sense, Sarenco). But is this a subjective test or an objective one? Clearly a roulette wheel objectively passes this test to be called a gamble. But as I understand him, Colm judges that Tesla is overvalued just as Boss thinks Bitcoin is a BOHA. Therefore Colm does not see himself as gambling, whereas you do - but that is just your judgement.
 
It’s a point that I’ve made before, and it is in no way personal to Colm. How on earth can the proverbial “man in his attic” think that he can outwit the hedge funds and the professional fund managers? How can he be spotting something in the P&L of one of the most talked about stocks in the world that gives him an edge over others with far greater resources?

I also have an issue with Colm’s targeted return; it’s been easier to deliver over the time period in question because of the bull market notwithstanding his concentrated approach. But is he “storing up” higher annual returns for the winter that will surely come?

I’m sorry, but I stand by my contention that the approach in question is deeply flawed.
 
Hi @Fella You've covered a lot of ground in relatively few words. Unfortunately, it will take many more words to address your questions/comments, but I'll try to deal with a few in this post, and maybe deal with the rest later.
Fella said:
The problem to me is there is more to the share price than the balance sheet ,
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Of course! I rarely look at the balance sheet when evaluating businesses, unless they're investment trust type businesses. If you go back to my original post in this thread, I spoke primarily about revenues and expenses (including spend on R&D, etc). I don't recall mentioning the balance sheet once. I mentioned Tesla's total market value, not to compare it with the balance sheet value of the assets, but to ascertain how much it should be knocking down in annual profits when it's mature to justify that valuation. The $2.5 billion figure I arrived at was calculated at 4% of the market value on Friday last.
Fella said:
maybe there is a belief that this it's just a matter of time before Tesla breakthrough and become huge and there's a Tesla in every driveway.
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You're absolutely right there. That's what's driving the share price. Yet the figures and considerable research (which I didn't go into in the article) don't support that belief. For example, I dealt earlier in this thread with the claim that it has a lead in self-driving technology. It's miles (excuse the pun) behind Google and other leading players in that space. It's simply not investing enough in R&D. You can't make a silk purse out of a sow's ear.

I used the "market is irrational" quote at the end of my article. Countless people have used it in the course of this thread. I think we all get the message by now. The trick is to make sure you can stay solvent until logic prevails. I reckon I'll be able to manage that.

Fella said:
If it was as simple as company values then the smart people would short all the investment trusts trading above NAV and sit back and clean up
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First of all, investment trusts are completely different animals to companies like Tesla. It's a red herring to drag them into this discussion, but I'm happy to take the question. For starters, it's important to point out to readers that the vast majority of investment trusts trade at a discount to NAV. In my diary update 16 of 14 August, titled "Psst, looking for a bargain?", I discussed an investment trust that was trading at a 47% discount to Net Asset Value (NAV), which explains the title of the article. I know of one very special investment trust that is trading at a premium to NAV. That's Berkshire Hathaway, Warren Buffett's company. I need to be careful what I say about Berkshire Hathaway, since I'm a director of one of its subsidiaries. Some say BH is trading at a premium to NAV because I'm on the board of a subsidiary, but the real reason may have more to do with Warren Buffett Investors believe that, despite his age, he'll be able to keep delivering the goods in future. Naturally, I can't comment.

Fella said:
Is it not fair to say that people belief in Elon Musk and the value he potentially will bring to the company will keep it inflated indefinitely until the time it is actually a very valuable company both in financials and sentiment ?
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Yes, they do believe in Elon Musk, but my point is that the belief has gone beyond the rational. It is now completely irrational. That's my opinion, of course. It's an opinion that is based partly on technical analysis (and I have probably downplayed the extent to which I've got my head around some of the numbers and the projections), but it is based more on a lifetime's experience of dealing with people running companies. I don't believe that Elon Musk has the temperament or the people skills to run a large-scale manufacturing business. As I wrote in an earlier post, the strategic goals keep changing quarter by quarter, the top personnel have short careers with the company, its capital position is shaky, it is not spending enough on R&D. There are a myriad more problems that could make it practically impossible to succeed long-term. I believe that, in some of these non-technical areas, my understanding of the challenges and the difficulties of overcoming them are superior to that of "the market", which is composed to a large extent of 28-year old whizz kids who know very little about the real world and pay far too much attention to what comes out of their spreadsheets, often based on questionable assumptions.
Fella said:
I don't think that Colm can know more than the markets .I believe that any functional market with enough action on both sides will find it's equilibrium at a fair value ,
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As I've written already, you're absolutely right 99% of the time (of course I don't mean that literally, but it's of the right order). I'm just saying that this is one of the 1%'s where it's wrong to trust the market. I see it a bit like Trump supporters. An awful lot of people believe in Trump even though logic says they shouldn't. The same is true of Elon Musk. Their belief is keeping the share price high, even though practically every analysis of the company I've read from any of the big investment houses conclude that it is woefully overvalued. As you say, that overvaluation could continue for a very long time, but reality will eventually prevail, through the profit and loss account (and the balance sheet, if Tesla needs to raise more capital - a strong possibility before too long, in my opinion). It could take a couple of years before reality prevails. I think it will prevail before then, but even if it takes that long, I'll still be OK. As Brendan intimates, I have a contingency plan, just in case I'm wrong. And I have been known to be wrong, as I've recounted many times in my diary entries. If I'm wrong, it's not the end of the world. I'll survive.
 
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Fella said:
Shorting is a gamble and the outcome is chance , it is no difference than going to a roulette wheel in my opinion , you cannot predict short term movements.
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Hi Fella

I fully agree with you that one cannot predict short term movements. And either buying or selling for the short term is gambling.

But that is not what "shorting" means. I have shorted Bitcoin and Tesla but for the long-term. I was in Tesla for about a year. I have been in Bitcoin for almost two years

Just as I cannot pick a winning stock, I can't pick a losing stock either... most of the time. But when the market has gone completely irrational as it has done with Bitcoin, I think it's an investment rather than a gamble.

These are very rare opportunities. The price of Bitcoin. The price of AIB shares before the restructuring. The dot.com bubble.

I think that Colm's short is fundamentally sound, but it's risky.


Fella said:
Investing in stocks long term has a positive expected return , shorting doesn't .
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Agree generally.
 
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Fella said:
When you log into your stock broker account do you get a warning saying 70% of people lose money investing ? I think not
When you long into your IG index you get such a warning .
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I don't get that warning. Being long a stock on IG is economically the same as being long the stock with your stockbroker - except for the costs. The stockbroker costs more up front what with commission and stamp but after about 4 years the cost of rolling over a long position on IG start to exceed the upfront costs of direct holdings.
Since we have been enjoying a fairly sustained bull run and the majority of IG punters are long, they should on balance be ahead of the game.
I don't want to go too far off topic but the punters also benefit from their gains, including divies, being tax free.
 

Surely it's not the same do you get dividends been long at IG?
 
Duke of Marmalade said:
Yep, otherwise shorties would have a field day coming to ex div
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It's still not the same though unless you had a unlimited bank , returns are rarely linear so even if a stock did well over 3 years , the person buying on the spreadbet would likely be wiped out by market volatility , that's perhaps why so many customers lose ? Whereas the person that buys the share is not forced to sell
 
Fella I don’t get that. A deposit plus a FSB long is exactly equal to a straight long
 
Duke of Marmalade said:
Fella I don’t get that. A deposit plus a FSB long is exactly equal to a straight long
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Well we have gone a bit off track and got onto long positions , my premise is still that shorts are gambling , interestingly when doing more reading about spreadbetting this has come up before , you are fairly consistent with your opinion I will give you that and you posts have educated me in a previous thread on this subject .

But ..... but Duke 2008 would say Colm was gambling ........

Now when it comes to stock trading I believe that all short positions have a negative expected return so short selling is in my book always gambling (unless hedging a direct long position).

Long positions should have a positive expected return but if the position is only very short term the risk would be disproportionate to the small positive expectation. In my book short term long positions are also gambling.

Of course, the Boss' definition is a bit more subtle, it refers to performing an activity over the long term. Perhaps a persistent strategy of short term long trading is in the long term investing after all, if you see what I mean.

Its just interesting to read that this has came up before I guess its not so clear cut https://www.askaboutmoney.com/threads/is-financial-spread-betting-gambling-or-investing.70918/page-7
 
@Duke of Marmalade and @Fella
You're both right; it's just that you have different starting assumptions. The Duke is assuming that someone taking up a long position deposits the full cost of the shares with the provider. Very few do, I would think. Most just put up the margin requirement (5% or whatever). That's the situation Fella is referring to. If I only put up the margin, any fall in the share price means I have to put up additional funds. Even the best calls are likely to have a few wobbles along the way, so additional margin calls are almost inevitable. There's a golden mean, where you put up more than the margin requirement but not the full cost of the shares.
 
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