Hi Barry,
A while back, I came across a piece somewhere on one of these threads declaring that shorting a stock based on valuation is sheer folly. At the time, it went completely over my head. I now agree with that concept, but with some qualification.
Established companies in established businesses such as autos, airlines, retailing, etc. might be successfully shorted based on valuation, especially in light of the fact that not much has changed in the company's basic business and after a careful review of the company's past cycles of multiples. However, new companies in new industries simply cannot be safely shorted on valuation alone. It's too difficult to determine to what extent the new industry will expand or who the most promising long-term players in that industry will be.
Though 100 or 200 times earnings sounds (and is) outrageous, it is not this number that will bring down the stock's price, though the high PE will certainly accelerate the stock's repricing when that time arrives.
No, it has to be something other than valuation, and that something is the opposite of what allows for the high prices in the first place. Once the limits of the new industry or a new stock in that industry become apparent to more than a few, then a chance to enter on the short side is a much better bet.
The problem for the shorts vis-…-vis AOL is that, aside from a high valuation (which attracts shorting of any company, whether warranted or not), AOL has quite a number of ancillary characteristics which would appear to indicate a short target as well. These include accounting irregularities, cash-flow problems, cumulative losses, atrocious customer service, multiple technical problems, poor security, and clumsy, intrusive over-use of advertising to name a few. We can now add poor relative pricing to the list, as well.
However, these are ALL red herrings, for the time being. None of it matters until the growth of the internet or the growth of this stock tops out. If growth in the industry or stock stops and the stock is still in the stratosphere, look out below. When it becomes clear that not everyone needs a Zip drive, or that most corporations can do without your particular Y2K software fix after all, or the competition pulls up a chair next to your's and begins eating your lunch, the party's over. The trick is being alert enough to detect the early signs that growth has peaked. At that time a partial short position, leaving room to average up, would be justified.
I would guess that AOL's growth will top out long before the internet in general does, but that's only because, at any given moment, AOL seems to be doing everything it can to drive away customers. AOL continues to succeed in spite of itself because the concept, utility, and value of "going on-line" continues to take hold. |
