This is really long, skip it if you have a short attention span -- just random ramblings from a psychotic AOL bear...
It is proper and beneficial that one should learn from one's mistakes and, to date, shorting AOL has been one of my better examples in this area.
I shorted something like a thousand shares in August at 65 and covered for a tax loss in December at around 90. I had been up about 40% for the year in this account, but ended the year about flat. Bummer. I've been waiting for an entry point to short again, but I'm really beginning to wonder...
I've made good money on other shorts that weren't nearly as compelling as AOL, and I still think AOL is a pretty much an earnings mirage, but I don't want to repeat this mistake again.
So, in post-mortem fashion, here's my stab at why this dog just won't roll over. Please feel free to comment on, elaborate, reduce, or enlarge this list -- it's far from comprehensive. My hope is that, together, we might come up with a list of reasons that, on the surface, appear to indicate a really good short, but, in fact, are strong reasons to stand aside or even go prudently long.
1. The company is in a brand-new, growing, though ill-defined business in which there is, as of yet, no established business model. No one knows how this thing will look in one year much less five. No one really knows what the gamut of services, partnerships, price points, annual costs, infrastructure life-cycles, total membership pools, etc. will be, hence the company can project anything they want and few can argue the point.
2. The company is unashamedly willing to undergo aggressive, coordinated, self-promotion. In other words, the company will say anything, including out-right misrepresentation in order to garner interest in and promote the company and its stock. Some self- promotion is normal, excessive self-promotion indicates someone wants this thing up -- now -- and if they have anything to do about it, the company's stock will be heading up.
3. The company is easy to tout to the institutional and retail investment communities. Once it becomes accepted as fact that the company is in a "growth" business and everyone has a passing notion of what that business is, the stock practically sells itself and always find support quickly on pullbacks, whether the company itself is actually "growing" (earnings) or not. The company is not sold on its track record or its current merits. Only the "future growth story" matters.
4. The company is a cash hog, demanding nearly constant infusions of cash in order to keep its "growth" prospects alive. This makes the stock a favored son among the investment banks and underwriters for both debt and equity. The company's balance sheet stinks and it always needs money. But the "story" is an easy sell, so the "story" is told, retold, and expanded by the very entities in charge of raising that money so that selling that debt and equity to the public is as quick, easy, and profitable as is possible.
5. The company has a history of playing earnings games, but no one, especially those whose job it is, notices or says much of anything. Problems in each quarter's earnings are downplayed or ignored. Earnings quality doesn't appear to matter, so long as an acceptable "number" is reported. The accompanying commentary and conference call downplay all current problems and concerns. If the immediate future is weakish or flat, the future is forecast as a bed of roses against a red sails in a red sunset viewed through rose-colored glasses, and few care or question it.
6. The stock is an obvious, screaming short, especially on (though not limited to) a valuation basis. As a result of #1 - #5 above, this often is the case. But how high is outrageously high? What is the ultimate catalyst for the long term top providing #1 - #5, or some combination thereof, is still in force? If and when that definitive catalyst occurs, how will we know? Technical analysis? Mass downgrades? What??
In each case listed above, a prudent investor would normally stand aside -- too many unknowns, too many questionable practices. Why all the games and puffery? It just doesn't pass the smell test. An aggressive investor (we shorts) do what comes natural, we short the damn thing.
I really don't know if the ability of a stock to rise rapidly pulling all this baggage is just a characteristic of THIS particular market (I suspect it might be), THIS particular stock, or if these rules might be applied successfully to other stocks in THIS market and OTHER markets. It might be interesting to locate other stocks that follow the AOL profile to some degree (YHOO, CIEN, AMZN, etc.) and maybe buy a few hundred shares with some protective puts or, if the options are as plump as AOL's, sell some covered calls.
Finally, One of the prime rules for selecting a stock to short goes something like "avoid shorting companies that really aren't all that bad". As bad as I believe think AOL is, long term, it probably turns out that AOL just isn't "all that bad". Don't get me wrong, the stock will pull back occasionally, even frequently, but it's probably more prudent to stand aside when a stock exhibits most of the characteristics enumerated above. Otherwise, as we have seen repeatedly, the shorts just become squeeze fodder for the market makers, actually improving the stock's overall upward momentum -- not what the shorts had in mind, at all... |
