Shortin' Ain't Easy
In a post the other day I mentioned The Big Picture's Barry Ritholtz's rules for shorting stocks that he has developed over many years of investing. The first two rules were the ones that really stuck with me:
1. Shorting Momentum names is dangerous: Unless you are Superman, never step in front of a speeding locomotive
2. Valuation alone is insufficient reason to get short a stock — History teaches us that cheap stocks can get cheaper, dear stocks can get more expensive
I have been burned numerous times shorting overvalued (at least in my opinion) momentum stocks here in CAPS. For the most part, the stocks that have burned me the worst are legitimate companies, often with solid businesses, that just appear to be wildly overvalued. Today I finally capitulated and closed a couple of this sort of trade of this type of short, including salesforce.com (CRM) and Blue Nile (NILE). I have been burned in the past by shorting companies like Netflix and Amazon.com. Fortunately all of these trades were only here in CAPS and not with real money.
Apparently, I'm not the only one who has run into trouble shorting momentum stocks with rich valuations. Super investor Whitney Tilson recently capitulated and significantly reduced his short positions in a number of companies.
Whitney Tilson Reduces Short Exposure, Refocuses on Buying Cheap Stocks
Whitney Tilson and Glenn Tongue's hedge fund T2 Partners have had some rough sledding the past few months, mainly due to their large short exposure. Over the last five months, they are down 4.3% net while the S&P 500 has rallied 23.5%. As such, they've re-examined their portfolio construction and have concluded to reduce short exposure and get back to basics: buying cheap stocks.
Rationale for Reducing Short Exposure
Tilson cites the fund's maintenance of a large short book after the crisis as the primary mistake. Additionally he writes,
"Over time we've been quite successful shorting fads, frauds, promotions, declining businesses, and bad balance sheets. Where have had much less success, however, especially in recent months, is shorting good businesses that are growing rapidly, even when their valuations appear extreme. Such open-ended situations, regardless of valuation, are very dangerous, so going forward we will avoid them entirely unless we have a high degree of conviction about a specific, near-term catalyst."
The immediate thing that comes to mind is their well-documented short position in Netflix (NFLX). This short is obviously classified as a 'valuation short' but T2 notes that they are still digesting the company's recent earnings as well as other channel checks and it is unclear as to whether or not they've adjusted their position in anyway.
Interesting stuff. I still have 19 short positions open here in CAPS. Using the logic that shorting pricy momentum stocks is dangerous, I probably should close my OpenTable short. I haven't yet because I think that its valuation is absurd. I also have not yet close my shorts of Tesla or RealD. The best type of shorts are outright frauds or situations / companies that are fundamentally flawed. I will continue to short stocks like these, but I plan on staying away from richly valued companies with solid businesses from now on.