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* Paper written by André Gosselin published on the
lesaffaires.com web site.
Before selling a stock short, said Peter Lynch, it is
necessary for you to have more than the conviction that the company is at the edge
of the disaster. You need the patience, the courage and the money necessary to
hold on if ever the stock does not fall, or worse, if it goes up.
"The stocks which price is supposed to drop but does not
drop, he writes with his famous sense of humour, remind me of these cartoon
characters who do not fall from cliffs but continue to run in the airs. As long as
they do not become aware of their difficult situation, they remain indefinitely up
there".
There are then many investors, those days, who lose
significant money trying to sell stocks short. Let us hope that they are not the
same ones as those lost so much with the blowing of the tech bubble, and who now
try to regain their funds by the mean of short selling.
Among the stocks having the strongest volumes of short
selling (in absolute figures), we can find Microsoft, INTEL, Cisco, Amazon.com,
Oracle, Dell, Amgen and Yahoo. One cannot say that those are companies on the edge
of the bankruptcy. Several experts in management would say that they are excellent
companies, among best managed and the most innovative in the world. Moreover,
Microsoft, INTEL and Cisco are also among the 20 stocks the most present in the
portfolio of the American households.
It is probably for this last reason, among others, that
some daring investors decide to sell them short. As remarkable as they are, they
generally believe that the stocks of these companies are traded at a too high
price.
Thus, it seems that a short selling strategy very popular
among our southern neighbours aims directly the most popular companies. It is not
possible to be more against the trend. These investors make simply the bet that
the most popular stocks are always too expensive, and that sooner or later they
will adjust to a more normal price. A bet that Peter Lynch would certainly find
too risky.
Of course, one finds in the list of the 20 favourite
candidates for short selling, some companies which by are not necessarily
recognized for their excellence. They have a worrying debt level, little or not of
profits, and their business model is very fragile and dubious. I think in
particular to Charter Communications, Sirius Satellites, XM Satellite Radio
operator, Level3 Communications, Nextel Communications, Comcast, InterActive Corp.
and Juniper Networks.
No more than ten studies can be found about the short
selling returns. Most of them show that this investment strategy, such as it
is practised on the American markets, is a profitable activity. Those who are
devoted to the short selling, observe the researchers, are more qualified and
informed investors that the average, and the return of their portfolio reflect
that.
The two most interesting and exhaustive researches, to my
knowledge, are related to the AMEX and NYSE markets for the 1976-1993 period
(Dechow and Al), and the Nasdaq market over the 1988-1994 period (Desai and Al).
In both cases, the researchers showed that the stocks the most sold short (by
comparing the proportion of their shares sold short with their volumes of
outstanding shares) generate indeed negative returns and thus, seemingly, profits
for the short sellers. And let us not forget that they had realized this
accomplishment in a strongly bullish market.
One imagines very well that their performance was even
better with the bearish markets in 2000, 2001 and 2002.
Dechow, P.M., Hutton, A.P., Meulbroek, L., et R.G. Sloan,
"Short sellers, fundamental analysis and stock returns", Journal of
Financial Economics, 61, 2001, p. 77-106.
Desai, H., Ramesh, K., Thiagarajan, S.R., et B.V.
Balachandran, "An investigation of the informational role of short interest in
the Nasdaq market", 2001, Journal of Finance.
André Gosselin
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