SHORTING STOCKS
Here's a good question I just got asked...
If you find a business that is massively overvalued like LLY seems to be right now, would you short it to make a bundle when it comes down?
Always do a 4M look at a business before you consider shorting (or doing Put options) to see if it has:
- Meaning to you (i.e., you understand the business)
- Moat (durable protection against competitors, and the Big Five numbers -- ROIC, Equity Growth Rate, EPS Growth Rate, Sales Growth Rate, & Cash -- are good)
- Great Management (level five leadership with a Big Audacious Goal)
- A big Margin of Safety (50% off the Sticker - the real value)
You must know that this business has no moat and that the ROIC sucks and the growth rates for Sales, EPS, Equity and Cash are below 10% for a long time.
You must know the management is incapable of fixing whatever is wrong and are in it for all the wrong reasons. And finally, you must know that it, like LLY, is selling well above the Sticker Price. Like double the sticker.
And then, before I short it, I would want to see that institutional money is pulling out and that the technical tools I use show me nothing but red. Then, and only then, would I feel okay about a short or a put.
In other words, you reverse the usual process and find a business that you understand well enough to know that it can't go up -- and it must go down.
But be very careful. Shorts are weird. Even if you are right, you can get burned. If there are lots of people shorting and the price goes up, they are losing money -- so many of them will have to go into the market and buy the stock to get out of their short position. And what will that do to the price? Make it go up even more... even though it shouldn't... which causes more pain for short sellers, who then cover by buying -- and against all reason it goes up more, which causes more pain ... You get the point. Shorting is an advanced game. Make sure you know what you are doing.
