DANCE WITH THE DEVIL
Taunting questions have been raised by the bulls. They say bears are wrong because AOL has risen from 40, 50, 60, to 80, and now at 90 as the bears sounded the same tune. In this post I will attempt to set aside the long rivalry between the bulls and the bears for the moment and offer some candid suggestions for the bulls. Bears should read this too because there is much at stake.
First I must declare my position. I shorted AOL at $83 last week, before then I had no position in AOL except my opinion that it is over priced. Selling short on Wall Street has so many dangers that I call it "Dance with the Devil." When I first started investing I promised myself I would never sell short, for it is too risky if a stock should double or triple afterwards on momentum. History shows a long term rising trend for the stock market so "time" works against me as well. Yet here I am shorting AOL. It is not a position I take lightly, and I continuously monitor information disseminated by bulls here and elsewhere against my own opinion to keep myself in check.
I came across an article by James J. Cramer, a CNBC personality who is also a commentator for theStreet.com. He wrote an article on October 23rd titled "Cramer on The Wonder of Stocks Like AOL" in which he gives reasons why he would not short AOL. He writes "So what?" to every reason emailed to him by his readers who shorted or is considering shorting AOL. The reasons are the same that appeared here: AOL has bad service, meager earnings, and "no real plan to move beyond subscriptions except a couple of companies willing to pay to get AOL's eyeballs." He is convinced that Wall Street loves AOL and with its current market capitalization, AOL could buy out companies that actually make money. Thus Cramer concludes he would not short AOL and taunts his readers not to be foolish.
I considered his arguments carefully. I read more of his writing on other stocks with a two-week free trial at theStreet.com. His trading strategy seems to be more "momentum" and day-trading than fundamental long-term investing. And I strongly disagree with his assessment on AOL. For one, AOL would not purchase local ISP's because their business are simply incompatible. AOL is getting out of the ISP business. It could purchase other content plus ISP vendors, but how many of those are left? Witness how CompuServe users flee the service on the mere smell of AOL. Microsoft needs MSN for its WebTV operation. So it comes down to the central question. Should one sell-short a story stock like AOL?
I don't think there is much disagreement between the bulls and the bears that AOL currently has very poor fundamentals. In a post last week I estimated the number of subscribers that AOL could possibly have in 3 years. It was 12 million. And in another post I separated AOL's revenue stream into three sources: ISP, advertising, and % profit of online sales. And one by one I came up with realistic numbers using modest estimates. But together they do not warrant AOL's current valuation. Other bears have contributed with other perspectives. AOL doesn't work as a mall for example. Members would receive group discount only if everyone purchase the same product, such as 56K modems. Beyond that there is little uniformity to AOL members. But most importantly, AOL's subscriber number is unverifiable and their non-audited earnings keep on changing.
Lest a ridiculous subscriber prediction, the bulls countered the bears with the stock price appreciation this year. Wall Street sure loves AOL. As long as the "strong buy" recommendations are in place, AOL will continue to rise regardless of fundamental or the lack of it. The "excitement" of earnings report and stock split surely will keep the stock price afloat for a while longer. These bullish views trouble me greatly as they reveal a confusion between the stock and the company. Incidentally the exact same thing Cramer accuses his readers who are shorting AOL.
As an investor, one should only invest in companies that has appreciation potential based sound fundamentals. Momentum investors and day-traders are short term players that don't follow this rule. Sometimes a stock can get "out of whack" by their actions or similar circumstances. AOL is one stock that is caught by several waves of momentum. If you are lucky enough to ride these waves, it's time to take your profit and smile from the sideline. If you are truly daring, you could write a few call options to squeeze a little more out of this ride. But don't kid yourself into thinking this ride will continue forever.
Selling-short is foreign to momentum players like Cramer. They take advantage of people's over-reaction and irrationality. Buy on rumor, sell at the end of the day. They ride on the back of people who sell short. So I don't put much credence in what Cramer has to say on this subject. Selling short on a stock so much "out of whack" like AOL is one of the smartest investment moves one could make. Although one can't predict which stock will be hyped up to unrealistic highs, one can certainly pick which stock has already been hyped up. And sooner or later, the company will catch up with the stock.
Timing a short is the difficult part. I said earlier selling short is like "Dancing with the Devil" due to the potential loss. Fortunately I have found ways to minimize such loss by ways of option buying and writing. The risk is still there, but substantially minimized. So while I still look over my shoulder, I am looking at my options and not at the Devil. I cannot time the demise, but I will be there to profit when it happens. That's for sure.
So what is the point of this post? The bears on this thread are not dummies. I am not just saying so because I am a bear. There is a lack of good bull posts with revenue projects and time tables. The bears, on the other hand, did the home works for the bulls. And the bears can even defend their position intelligently against the likes of Cramer. So don't ignore the bears. AOL is a story stock that is reading its last chapter. One analyst issued a "sell" this week. Independent report shows a dramatic slow down in new subscribers. Earnings due in two weeks will probably fall short of the estimate. It's only a matter of time before the big selling begins.
Here is a candid advise to the bulls. If you own shares of AOL, let's say 1,000 shares, write Jan or Apr calls on them. Jan 85c is currently at $10. So you could write 10 contracts for $10,000. If AOL drops 10 points in November, cover your options at $3,000 and sell your AOL shares for $76,000. Your net will be $83,000, $7,000 more than without writing the call option.
Your Friendly Bear,
Yikes |
