Streetsmart Guide to Short Selling (Tom Taulli) 0 comments

Assuming the market moves up one-third of the time, sideways another one-third, and down the final one-third, the long-only investor stands to gain from the market trend only one-third of the time. In fact, assuming that stocks fall as a result of their own weight, they could be subject to headwinds the other two-third of the time. Surely the enterprising investor should look to capture some profit from this two-third pie? That's where the above book comes in.

Written in 2003, its timing was probably inspired by the bear years of 2001-2002. The approach is quite methodical: it discusses the what, how, why and most importantly, when, aspects of short-selling, in that chronological order, and is quite easy to read (perhaps the large font helps).

The context is the US market, so be careful about the "how" aspects. Generally the US market is more developed for short-selling and there are a greater number of stock scrips available for borrowing for short-sellers and there are even market statistics for short-selling (short interest ie. uncovered shorts) while in Singapore naked short-sellers have to contra within one day and there are limited stock scrips available for borrowing to short extended periods.

There are fourteen chapters in the book: the first four cover the what, how and why aspects to give an introduction to the novice. The next eight cover the "when" aspects, which is probably the meat of the book. There is strong focus on accounting statements (four chapters), with one chapter each for balance sheet analysis, P&L statement analysis, cashflow statement analysis (with the other being a general assessment of accounting rules). There is a chapter on insider sales, which gives an indication of just how important this is as in indication of declining company fortunes: a corresponding belief of mine. There is a chapter on technical analysis which chartists will love, and then a chapter on "special situation shorts": tech companies, finance companies and IPOs (tech and IPOs are pretty understandable, but finance is because if the trust in the bank is gone, customers will desert pretty fast).

But the most interesting and informative chapter is Chapter 5: Making the Case for a Short Sale. If you don't read anything, read this part: it lists the danger signs and trigger events for a short sale. Danger signs are clues (usually qualitative) that the business is having problems; trigger events are the catalysts that might prompt a run on the stock. Samples: danger signs listed and discussed in the book include fads (volatile), loss of strong growth, flawed business model, hype, public skepticism (can be verified by trips to the mall to assess product demand), mergers (1+1<2); trigger events include drastic fall in price despite seemingly strong business (eg, ACCS), resignations (especially key personnel), earnings below expectations, delayed financials announcements (usually bad), reverse splits, regulatory actions.

This book can be a contrarian guide for the long-only investor. Instead of reading books which preach on how to select good companies and stocks, he can comb through this short-selling guide to get an idea of how to spot danger stocks that he should avoid with a ten-foot pole. That is where the value in this book lies, to me.