February 15, 2019
It’s A Certainty
I’ve had short-selling on the brain this past week. I gave a talk on Tuesday night about my involvement with the film Betting On Zero, about the battle between multi-level marketing giant Herbalife and hedge fund titan Bill Ackman, who was short $1 billion of Herbalife shares. I was an executive producer. The film was nominated for Best Documentary by the Writers Guild, won a special jury prize for investigative filmmaking at TriBeCa Film Festival, and has a 100 percent positive rating on Rotten Tomatoes. I’m proud of it. But it doesn’t change the fact that the guy I was rooting for lost.
The film follows Bill Ackman around for two years as he tries to convince Wall Street, and regulators, that Herbalife is an illegal pyramid scheme. Unfortunately for Mr. Ackman, his nemesis Carl Icahn showed up and bought a massive stake in the company, essentially providing the company with a much-needed bulwark. And when the FTC finally did come down on Herbalife, it stopped short of calling the company a pyramid scheme. Yes, the FTC handed down its largest fine ever ($200 million) and instructed the company to fundamentally change its business, but Herbalife avoided the death penalty. The then Chairman of the FTC, Edith Ramirez, spared the axe, but famously said at the press conference that Herbalife was “not not a pyramid scheme.” Ackman eventually was forced to cover his firm’s short position at a loss estimated in the hundreds of millions of dollars.
There were a number of lessons I took away from watching this saga unfold, up close, over several years. Some are along the philosophical lines, such as don’t take a moral argument to Wall Street. Markets are amoral. Markets quickly reflect probabilities of outcomes and discounted cash flows—they do not normally hand out Good Sport Awards. Another lesson is more of a trading rule. Even when you are absolutely certain you’re right, allow for the fact that you might be wrong. There’s a great scene in Betting On Zero in which Ackman’s PR expert is asking him what he should say if, after his imminent presentation the stock goes higher, Ackman says, “It’s not going higher. It’s a certainty.” The stock closed up almost 25 percent.
(It’s now a joke in my household. When I tell my wife or my children about a strong view I have on a given subject, I punctuate my statement with, “It’s a certainty.”)
A really important lesson I took from Betting On Zero though, even though I knew it before, was: shorting stocks is hard. I have advised clients who were short stocks for many years, and it just doesn’t seem like it ever gets any easier. For example, today, I’m looking at the stocks on my screen and the two biggest weekly movers UP are two names on my list of names I have been watching as shorts. The moves are massive—both up 30 percent this week. Few investors have the resources and risk controls in place to successfully short stocks over the long term. As a friend of mine once observed, “you don’t see any libraries named after short-sellers.”
Yet, I have always pulled for them. Shorting takes such massive conviction, knowing the market usually goes up and yet being so confident in one’s work to take a position anyway. I believe short sellers are essentially the beat cops of the market. They keep things from getting out of control.
For the most part though, I now recommend that investors let the beat cops do their work and avoid battleground stocks. It’s usually a better idea to avoid the names that attract the ire of short-sellers, and allow one’s portfolio to be the beneficiary of the omission of mistakes, rather than having to incorporate the risk of adverse market move, especially with rates as low as they are, not to mention all the years of quantitative easing beating shorts in the face. It’s just a better use of time and resources finding great businesses.
I’ll never swear off shorting, just like I’ll likely never swear off pepperoni pizza, but like pizza, too much of it isn’t really that good for you in the long term.
Maybe I should try a protein shake instead.
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