OT re shorting (gosh I'm so easy to goad into posting about shorting on this hallowed ground -- sorry! Though there is a snippet or two about value buying of distressed junk bonds, and USU...)
(I think Ben must be turning in his grave, not smiling! ;-)
There's four types of shorting that I can think of off the top of my head:
- overvalued stock (but otherwise good company, management, business)
- arbitrage
- bankruptcy-in-the-making
- fraud/scam/pump 'n dump/hype
I've done each type except for arbitrage. Category #1 has always, every single time, lost me money (SBUX. AOL. SBUX again. Japanese Yen. Canadian Dollar). Categories 3 & 4 have been surprisingly profitable and worthwhile. I think James is suggesting that Sunbeam falls into category 3, which I hadn't thought of but suppose it might very well. Now I've gotta follow up on his lead... ;-)
One kind of bankruptcy-in-the-making can be remarkably easy to analyze is the case in which a company has overburdened itself with so much debt that recovery is likely impossible, even if all sorts of things go right. For an aviation or racing analogy, think of it as getting behind debt's power curve. One good short of this type that I made was the gold miner Royal Oak, which had piled on so much high interest debt that no matter what happened (even if gold went to $375 an ounce the day after I shorted the stock), the common shareholder equity was doomed. No matter how you ran the numbers, it was only going to be a matter of time before the creditors ended up owning the pieces, the only uncertainty was the exact timing. In many of these cases the company survives, though through bankruptcy restructuring the creditors end up taking a haircut and owning the company (and the former common shareholders lose essentially 100%). In the case of Royal Oak I suspect it will be broken up and the creditors will be very unhappy with what little they recover.
I'm also short funeral home consolidator and operator Loewen Group. In this case I think the common stock is worthless with a safety factor of several times, even though I am sure that the underlying business will continue to operate and continue to be profitable -- it's just that during their crazy "no price is too high" rollup days they took on too much debt ($2.2B). Overpaying for your acquisitions with stock is bad, bad, bad. But overpaying for your acquisitions with debt is so much worse it can be lethal. The former dilutes shareholder value, the latter can eliminate it. Interestingly, I felt that their bonds were trading cheaply enough and their business was viable enough that I felt the bonds represented good value (hah! so that's a pice of on-topic value investing for ya!). I ended up shorting a small amount of their common (at $3 Cdn) and buying a larger amount (7X more) of their '02 bonds (at 50). Each side of this trade has gone well so far, though I think it is unusual to have such a stable, well defined business such that one can be confident enough one's valuation of the company such that you're willing to bet against both the stock market and the bond market at the same time. At this point FWIW the common is at $1.8 Cdn (having traded as low as 30 cents) and I'm thinking of shorting some more, and the bonds are now up to 66 (I won't buy any more at that price, but I will hold what I have either until maturity, for a YTM of about 30%, or debt restructuring -- who knows, it's not out of the question that I might yet turn out to be a long term shareholder of this company I've shorted!).
W.r.t. Sunbeam the thing to figure is, if management is able to somehow run it as a top flight profitable business (for its category), would they fall significantly short of the required interest payments? If so, then the outcome for the common equity is inevitable (zero, sooner or later). What happens to the value of their bonds and debt is less clear and more dependent on the path taken by management and creditors -- one would have to be fairly confident of one's analysis before wading into the bond arena.
James, it is interesting to know that you're going short (one can use it as either a bearish or bullish indicator ;-). Something you have not mentioned though, and is critically important for us to have in order to understand your outlook, is the size of your short positions w.r.t. your total equity and/or your total long positions. This size would tell us whether you're thinking about a long term outlook (a relatively small, defendable short position that could be held more or less indefintely without the need to use stop losses), for the short term (a larger, more vulnerable but more aggressive short position -- stop losses needed for this size position), or about blowing your brains out (far too big a position to hold or defend, always a coupla ticks away from suffering a "permanent loss of capital" -- I just love that Buffettism!).
FWIW my small taxable trading account is 88% short, 0% long (I find it so hard to find stocks to buy, even though this is one of my favorite threads!), which is less leveraged than it has been and yet I am trying to further reduce my short position (because of the high margin requirements on the low price stocks I find myself short now, I'm only 11.5% away from a margin call, which is far too close for prudence). My tax sheltered account (2.4X as large as my trading account) is 0% short (not possible to short in it), 32% cash, 35% long equities (USU and SRG.TO arbitrage) and 33% junk bond (LWN) (should probably be thought of more as a pseudo equity play than a "bond" grade investment as such).
So James, how short are ya? Just because there's an idiot stock that's overvalued 50X beyond all possible reason doesn't mean the market won't get even more irrational and drive you into insolvency in the short term, even if you're right in the long term. Shorting highfliers, or (way?)overvalued good companies strikes me as a one dimensional bet -- you're counting on a severe market correction or better. If you're wrong, you lose the bet.
I've been very bearish since the summer of '96 when I realized that the little bit of money I had just so easily (a double!) made on Iomega had just been way way too easy, and therefore the market was going to crash by October (of '96). My impeccable market timing record has continued to date... :-(
That's why I try to add another dimension to my shorts. If I'm shorting a fraud or a bankruptcy-in-slow-motion-before-your-very-eyes, it can succeed (as a short) even if the market doesn't crash. I'm assuming that this sort of short would also do well in a crash too.
Interestingly, I think some of the high fliers might be more attractive (and safer!) shorts *after* a market cash. Amazon sure seems to suck as a business, but they do have a lot of cash to burn and so long as the market has not broken, there is the not insubstantial risk that they can continue to raise money to burn through more debt or stock sales, and succeed in bucking off even determined shorts. But if the spirit of the market breaks and Amazon falls to (say) $25, it could (I haven't run the numbers) be an excellent short, safe enough to take a much bigger position in, on the assumption that their future access to cash would be cut off (people no longer in the mood to give them money to burn). Until the irrational exuberance breaks though, I just can't see how it would be safe to take a large enough position in Amazon.
W.r.t. whether we have a crash of historic proportions and whether it happens sooner or later, I think I finally understand enough to say that I just don't know. I think it is a very real possibility, and it would be foolish to bet against a crash, however it doesn't strike me as a sure thing to bet *on* a crash happening either. What I will say is that I fear (and predict!) that the average stock portfolio today will probably be worth about the same in ten years, though I don't pretend to know the details of how it might get there from here. I am bothered when I think about how most people I know would be truly financially hurt by no growth over ten years, let alone a psychologically damaging crash (and the irrational responses that that would surely engender).
- Daniel |
