Jim Chanos recently gave an interesting interview on the power of negative thinking and the benefits of short selling. Most interesting were the 4 major themes Chanos looks for in his short positions. Much like a long only macro thinker Chanos develops his specific short positions from much larger macro themes. In the article he detailed the 4 themes he looks for:
Some recurring themes in shorting selling:
- Booms that go bust – define boom as anything that is fueled by debt in which the cash flows produced by the asset do not cover the cost of the debt. The internet is not a boom since they didn’t have debt. The telecom bubble that went along with it was.
- Consumer fads – Investors like to extrapolate strong growth well further into the future than they should. It’s also a great source of decoration for your office, he’s got a Cabbage Patch Kid next to a George Forman Grill next to a Nordic Trak.
- Technological Obsolescence – Everyone thinks the old product will last longer than it actually does. Examples were Wang Word Processors (replaced by PCs), Record Stores (replaced by digital downloads). He says the internet is the cheapest way to distribute anything. However, people are still renting DVDs by mail, which surprises him (hint: likely short Netflix!). These businesses always look cheap but the cash flow goes down just as fast as the share price (think Kodak film).
- Structurally flawed accounting – Beware serial acquirers, they often write down the assets of the acquired firm in the stub period that no one sees. Ask management what the nets assets of the firm were on their latest end of quarter and what they were when they were acquired. Most management won’t tell you this, some will, however. But by writing down inventory and A/R they can “spring load” results once the company is acquired. They’re supposed to adjust the purchase price, but more don’t.
Source: Market Folly
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.