Short selling a stock is one of the most audacious gambits an investor can play. When an investor is long their downside is limited to 100% – they can only lose their total investment. However, when short sellers are wrong and the stock increases – it can increase endlessly, creating an unlimited downside for the short seller. Understanding how short selling works is crucial for those thick-skinned investors that are willing to bet against some of the world’s largest and most successful companies.
Short selling is not just about being right; it’s about being right when the market is ready to agree with you.
There was a time when Amazon only sold books. We know the company now for its eCommerce prowess; fast delivery, competitive pricing, and innovative consumer-focused products such as Alexa. Believe it or not, in the early 2010s many contrarian investors looked at Amazon with disbelief. Back then most consumers knew Amazon for it’s Kindle – a portable eBook reader – and short sellers weren’t convinced it would sell. Amazon’s commitment to never post a big profit, always reinvesting its revenue, didn’t sit will with traditional hedge fund managers either.
From 2009 to 2019 Amazon’s stock rose from a dwindling $35 to it’s current mammoth share price above $1700. Amazon short sellers just couldn’t see the forest for the trees; focusing on exorbitant valuations and lack of (explicit) profitability. It’s now the third largest company in the world and approaching a market cap of $1 trillion.
Bill Ackman, of Pershing Square, famously squared off against Herbalife in a short position that spanned three years, yielded two movies, and several 4-hour long presentations – only to cost him close to $1 billion. Bill Ackman was also unsuccessfully long on Valeant Pharmaceuticals a few years prior.
Ackman argued that the company is fraudulent by design. They employ multi-level-marketing (MLM) that deceives consumers, rewarding only a lucky few at the top (legalized ponzi schemes basically). He believed that the pyramid-scheme business model was, ultimately, not sustainable, and that when consumers would catch on – they would abandon the products and the company would crumble. Unfortunately, Herbalife’s model held longer than Ackman’s short. The company continued to sell more products, expand into other countries, and the stock price climbed. After years of short interest payments eating into his profits, he was forced to close his position at a loss. Perhaps Bill Ackman was right for bringing to light the unethical model of the firm, but he failed to convince consumers or Wall Street.
Tesla Inc. and Elon Musk are Wall Street’s favorite company and CEO to pick on. Tesla IPOed in 2010 at $17.00 per share, and by autumn 2013 was trading at $194. The business was – and still is – disruptive to the entire automotive sector, and naturally upset many industry traditionalists. In early 2013, as the stock was gaining more popularity, and the company’s fanbase continued to grow, many activist investors expressed their dissatisfaction with the market valuation and announced their shorts. Many didn’t believe that the market could sustain a demand for electric vehicles, or that a manufacturer could create an electric vehicle that could compete with cheaper gasoline cars.
As we all know, short sellers were left disappointed as the company proved there was a demand for their product and that they could scale. The stock has since reached an all-time high of $380, albeit now trading at around $250. The company is still one of the biggest controversies on the market, boasting a high short interest. Only time will tell if Elon Musk will be able to rally company performance to a level that warrants its now $43 billion valuation which exceeds Ford and nearly matches General Motors.
Remember: short selling is not just about being right; it’s about being right when the market is ready to agree with you. So note the mistakes, but focus on the strategies that win.
Disclaimer: All investments involve risk, and the past performance of a security, industry, sector, market, financial product, trading strategy, or individual’s trading does not guarantee future results or returns. Investors are fully responsible for any investment decisions they make. Such decisions should be based solely on an evaluation of their financial circumstances, investment objectives, risk tolerance, and liquidity needs. This post does not constitute investment advice.
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