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anticitrade (99.46)

Is shorting black magic? What do you think?

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April 20, 2009 – Comments (13) | RELATED TICKERS: GMO , GGR , CEP

Yesterday, I fully intended to write a blog post about all the reasons I hate shorting.  To establish some credibility on the subject, I even created a new Motley Fool account of the top 200 short stocks from my automated program.  However, the account I created backfired on me.  This short account is beating 94.89% of investors after a single morning of operation.  I expect with a longer time horizon that this account will serve its original purpose.  Meanwhile, I have to accept the possibility that I have been wrong about shorting.  It may not be just speculative/technical black magic.

To see this short account check out: http://caps.fool.com/player/anticitradeshort.aspx

To learn more about my program, go to www.anticitrade.com its free to sign up.

13 Comments – Post Your Own

#1) On April 20, 2009 at 12:18 PM, icuryy4me (< 20) wrote:

I would say that one morning is not a meaniful timescale. Tomorrow you could be ranked zero.

 

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#2) On April 20, 2009 at 12:44 PM, anticitrade (99.46) wrote:

I hope you are right.  That would certainly support what I originally wanted to say today.

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#3) On April 20, 2009 at 1:15 PM, motleyanimal (98.93) wrote:

The final 30 minutes will be fun to watch today.

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#4) On April 20, 2009 at 1:16 PM, goldminingXpert (99.97) wrote:

All I have to say is that I'm very dissappointed that your screen would come up with JAG as a short. That just amazes me.

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#5) On April 20, 2009 at 1:30 PM, anticitrade (99.46) wrote:

I take your opinion very seriously goldminingXpert.  So I did a little more analysis on JAG.

My automated DCF doesn’t like their consistent high operating expenses ("other" expenses shows a strong trend up).  Also they show consistent high investment (relative to sales) in both PPE and NWC. 

However, my program found a very beneficial trend in both their COGS as a % of sales, and  SGA Expense as a % of sales.

Of the 10 total prices I generate for this company on 2 of them are positive.  One is at 5.65 the other is at 1.62.  Obviously, an automated system does not consider a SWOT analysis, or any of the soft issues that may indicate that this stock is a great buy.

I hope that helps?  Personally, I don’t have a lot of confidence in any automated systems ability to pick short stocks, because it is usually based on the absence of reasons to buy a stock and not on actual reasons to short it.

Thanks for your comments.

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#6) On April 20, 2009 at 1:35 PM, goldminingXpert (99.97) wrote:

Sorry, my post was way too harsh. I meant that as a joke but it came off as a complaint. I'll look at those figures more closely. Intesting stuff you're doing.

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#7) On April 20, 2009 at 2:13 PM, russiangambit (99.02) wrote:

I kind of like NUVA. What is wrong with it? What made FCX to go on the short list? Too much debt, overvalued?

One has to admire your timing skills. You open a long account at the bottom and short one at top. -))

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#8) On April 20, 2009 at 3:03 PM, anticitrade (99.46) wrote:

I hear that it’s better to be lucky than good.

NUVA is a good example of why I think shorting is soooo speculative.  How do you value a company that has a negative operating income for 7 years? 

That said, in 2011 I see NUVA finally making a positive operating profit.  This is a result of a very strong trend towards a higher gross margin on their sales.  To their credit they also show decreasing expenses as a percent of sales.

If it wasn’t for the trends I am seeing in their fixed asset turnover I think they could be a good buy from the discounted cash flow analysis.

I have enough information on this company to produce 4 positive prices for them 2.89, 11.48, 32.8, and 25.56.  The other 6 valuations I do all yield negative values.  With a current price of 30, I only have one reason of 10 to buy them (without consideration for other potential important soft issues).

As for FCX most of their problem is that they had pretty terrible results in 2008.  My forecast obviously weights the most recent data heavier than the past, so it’s no wonder that the analysis is not optimistic about this company.

Just for giggles I removed their recent $17 B other expense in 2008 from the calculations to see how that would affect things.  They still have such a low fixed asset turnover, that any free cash is consumed there.  Maybe someday soon this will change, but I am not particularly good at speculation (my luck tends to be limited to timing).

Thanks for the comment.

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#9) On April 20, 2009 at 4:56 PM, goldminingXpert (99.97) wrote:

Why is high investment in parts/plants/equipment necessarily a bad thing? When revenue is growing at 100% a year as it is at JAG, don't you expect to see a lot of spending on growth? I am not too familiar with the Net Working Capital accounting figure--how does it relate to JAG?

"However, my program found a very beneficial trend in both their COGS as a % of sales, and SGA Expense as a % of sales. "

I assume this means their cost of goods is falling? I can see how that would be good. Am I interpreting that right?

"Of the 10 total prices I generate for this company on 2 of them are positive. One is at 5.65 the other is at 1.62."

Positive prices. This means upside from the current price of $5, or you just mean a value over zero? does 5.65 actually mean ~10.65 or what? And where does revenue growth/turning a profit for the first time fit in? I'd assume the company will get, if nothing else, a strong psychological benefit from the extreme revenue growth and the fact the company is profitable.

I am an interested observer in how a business is valued via model but I have little experience here so I appreciate your posts.

GMX.

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#10) On April 20, 2009 at 6:11 PM, anticitrade (99.46) wrote:

Actually, investment in PPE is one of my greatest problems with the DCF model.  The problem is that this evaluation is based on the concept that you can value a company from the free cash flows that will be available to investors.  Consequently, if a company always invests more money in PPE than it generates through operations, the company will appear to have a negative value. 

Some companies reach a point where they can back off on this investment and start generating a positive cash flow, others never do.  My model looks for trends in these numbers to try to determine how this investment will change in the next 5 years.  I have tested various methods of creating a equilibrium factor that assumed that after 5 years the company stopped growing, but the principle could not be applied universally without producing unsatisfactory results. 

Investment in net working capital is a different matter.  If a company is growing their balances in inventory, accounts receivable and other current assets faster than they are growing their balances in accounts payables and other current liabilities, this ties up cash flow.  I am much less forgiving about a company losing control over its current assets and liabilities than I am about PPE.

Essentially, companies which are growing quickly are less predictable and more likely to consume all free cash for their growth.  I tend to believe that these stocks should be chosen mostly on speculation.  Consequently, I have created flags for stocks where this is the case on anticitrade.com.

You are interpreting what I meant about the COGS correctly.  As far as positive prices are concerned, I consider any price above 0 a positive price.  DCF models can easily generate negative values for stocks (this often means that a DCF model is not appropriate for this stock).  In my valuation I base the price heavily on earnings, so companies with a negative net income generally rate very low. 

When I say that “revenue growth/turning a profit”, it just means that forecast of all the individual items on their income statement and balance sheet show that the will begin producing a positive net income at some point in the near future.  My system does not consider the psychological impacts that future results may have on people. 

This was a pretty tough question for me to answer.  And I am sure that I left some areas either unclear or just wrong.  I am always amazed when the DCF model suggests a reasonable price; if I was a sucker for punishment I would do a PhD on it.

 

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#11) On April 20, 2009 at 8:46 PM, goldminingXpert (99.97) wrote:

Great answer. Very informative. I can see how PPE would be a trick factor then. Maybe DCF doesn't work as well for new companies? It is hard to treat JAG fairly as it never has reached a "normal" cycle of operations. It has been frantically growing since the moment it IPOed. With the company at the threshold of becoming consistently profitable and with revenue growth still in the stratosphere, JAG clearly has a fair bit of value. However, you are right in that if they don't slow the rate of growth, eventually they will consume all their capital and die. Interesting question--how does one value that? There's also the question of industry. JAG is virtually unhedged--if gold goes up, JAG goes up in multiples of the rise of gold as their earnings are essentially a call option on the price of gold. If gold goes to $400/OZ, JAG has no value, if gold goes to $2,000/OZ, I betcha JAG is worth $50+ a share. How on earth do you value that? Crazy.

Maybe you should consider exempting young companies from your model? I think JAG is a very foolish short at this point as you just don't know what management will do. Will they be responsible and cut back on the growth rate or will they go nuts?

One more question for you. Does your model take into account FX at all? JAG pays their bills in Brazilian currency, their financials are reported in Canadian dollars and then are translated into American dollars for us U.S. investors. Are you looking at their finances in CAD or USD and does the effect of the widely fluctuating Brazilian currency rate impact things at all?

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#12) On April 20, 2009 at 9:16 PM, anticitrade (99.46) wrote:

I agree that a DCF model (like most analytical methods) does a poor job of evaluating new growth companies.  I think these stocks can be only be valued with informed speculation. 

Actually, when I was putting in my shorts yesterday, I had to try nearly 600 before I could find 200 that Motley Fool would accept.   Needless to say, that portfolio is probably filled with poorly chosen shorts.  I really think automating short picks is much more difficult than automating long ones.

I will program it so it no longer suggests new growth companies and see if that helps.  It would be really helpful if someone, who was good at picking shorts, could tell me about their process so I could automate it.

My model does not account of FX, which after your explanation of the currency issues surrounding JAG, sounds like a really good idea. 

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#13) On April 20, 2009 at 9:40 PM, OldEnglish (27.62) wrote:

"It may not be just speculative/technical black magic." Looking at your picks, I'd say you're right.  RPRX dragging down shareholders for another twenty years doesn't seem speculative. A short position (at higher levels) is likely a bond quality investment.

 

 

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