"What Long Term Investors Can and SHOULD LEARN From Short Sellers"
Let me make it clear at the outset that I had never done short selling nor do I plan to do in future. But I found principles of short selling technique to be equally helpful to long-term investors. For short sellers the maximum upside is 100% whereas downside is unlimited. These asymmetrical returns force short sellers to be much more diligent and conservative compared to long only investors. I was surprised to note that most successful short sellers never short any stock merely on over-valuation. I am not talking here about short sellers who short a stock in the morning and cover their position by the end of the day. I am talking about short sellers, who after deep analysis create a position and hold on to it until their conviction pays off.
Charlie Munger once said, ‘All I ever want to know is where I’m going to die, so I never go there’. My sole attempt at studying short selling technique is to find what successful short sellers look for in a good short and to avoid such stocks.
Successful short sellers look for the following before they decide to short any stock:
- Business : Secular problems or fundamental change in the nature of business.
- People: Dishonest and incompetent management.
- Balance Sheet: Higher leverage is preferred.
- Profit & Loss account: Quality & Sustainability of earnings. Simple overstatement of earnings is not enough. Short sellers are looking for cases where economic reality is significantly divorced from the accounting presentation of the business.
- Price: Valuation is given least preference by most short sellers.
Many interesting links are also to be found in the above article.
A good (albeit almost 20 years old) book is "The Art of Short Selling" by Kathryn Staley: