34 highlights
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The story resonates because it has all of the elements of a David versus Goliath battle, and given the low esteem that many hold Wall Street in, it has led to sideline cheerleading.
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When most of look at investing, we think of stocks that we believe (based upon research, instinct or innuendo) will go up in value and buying those stocks; in investing parlance, if you do this, you have a “long” position.
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For those of you tempted to put all of Wall Street into one basket, it is worth noting that the biggest segment of professional money management still remains the mutual fund business, and mutual funds are almost all restricted to long only positions.
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But what if you think a stock is too highly priced and is likely to go down? If you already own the stock, you can sell it, but if you don’t have a position in the stock and want to monetize your pessimistic point of view, you can borrow shares in the stock and sell them, with an obligation to return the shares at a specified point in time in the future. This is a “short” sale, and if you are right and the stock price drops, you can buy the shares at the now “discounted” price, return them to the original owner and keep the difference as your profit.
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Short sellers have never been popular in markets, and that dislike is widely spread, not just among small investors, but also among corporate CEOs, and many institutional investors.
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I don’t believe that there is anything inherently immoral about being a pessimist on markets, and that short selling serves a purpose in well-functioning markets, as a counter balance to relentless and sometimes baseless optimism.
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While you may be able to sell short on a very liquid, widely traded stock for a longer period, on most stocks, your short sale comes with a clock that is ticking from the moment you initiate your short sale.
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Consequently, short sellers often try to speed the process along, going public with their reasons for why the stock is destined to fall, and they sometimes step over the line, orchestrating concerted attempts to create panic selling.
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Since short sellers have potentially unlimited losses, these stock price increases may force them to buy back shares in the market to cover their short position, in the process pushing prices up even more. In a short squeeze, this cycle speeds up to the point that short sellers have no choice but to exit the position.
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In 1862, Cornelius Vanderbilt squeezed out short sellers in Harlem Railroad, and used his power to gain full control of the New York railroad business.
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lest you fall into the trap of believing that this is a purely US phenomenon, the short sale with the largest dollar consequences was the one on Volkswagen in 2008, when Porsche bought enough shares in Volkswagen to squeeze short sellers in the stock, and briefly made Volkswagen the highest market cap company in the world.
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There have been at least three and perhaps as many as five short squeezes on Tesla, with the most recent one occurring at the start of 2020.
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As the shutdown put their stores out of business, the debt and lease payments that are par for the course for any brick-and-mortar retailer threatened to push them into financial distress.
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While mutual funds are often constrained to be hold only long positions, hedge funds have the capacity to play both sides of the game, though some are more active on the short side than others.
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Note that short seller interest in GameStop first picked up in 2019, and then steadily built up in 2020.
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To show you how quickly this game has shifted, Andrew Left, one of the short sellers, put out a thesis on January 21, where he argued that GameStop was in terminal decline, and going to zero. While his intent may have been to counter what many believed was a short squeeze on the stock in the prior two days, it backfired by drawing attention to the squeeze and drawing in more buyers.
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This surge in stock prices was catastrophic for short sellers, many of whom closed out (or tried to close out) their short positions, in the process pushing up prices even more.
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On January 27 and 28, regulators and trading platforms acted to curb trading on GameStop, ostensibly to bring stability back to markets, but traders were convinced that the establishment was changing the rules of the game to keep them from winning.
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If you believe this valuation, you would have been a strong buyer of GameStop for much of last year, since it traded well below my $47 estimate. After the spectacular price run up in the last two weeks, though, there is no valuation justification left. To see why, take a look at how much the value per share changes as you change your assumptions about revenues and operating margins, the two key drivers of value.
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It should therefore not come as a surprise that the forces playing out in other aspects of human behavior find their way into markets. In particular, there are three broad trends from the last decade at play here:
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To put the GameStop trading frenzy in perspective, let’s start with the recognition that markets are not magical mechanisms, but represent aggregations of human beings making investment judgments, some buying and some selling, for a variety of reasons, ranging from the absurd to the profound.
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For the most part, we trusted assumed that their superior knowledge and experience equipped them to take the right actions, and with our limited access to information, we often were kept in the dark, when they were wrong. That pact has been shattered by a combination of arrogance on the part of experts and catastrophic policy failures, with the 2008 banking crisis acting as a wake up call.
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A loss of faith in experts (economic, scientific, financial, government):
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An unquestioning worship of crowd wisdom, combined with an empowering of crowds
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We pick the restaurants we eat at, based on Yelp reviews, the movies we watch on Rotten Tomatoes and the items we buy on customer reviews. Social media has made it easier to get crowd input (online), and precipitate crowd actions.
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A conversion of disagreements in every arena into the personal and the political
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One reason that the Redditors targeted GameStop is because they viewed hedge funds as part of the “expert” class, and consequently incapable of getting things right
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Finally, even a casual perusal of the comments on the Reddit thread exposes how much of this is personal, with far more comments about how this would teach hedge funds and Wall Street a lesson than there were about GameStop the company.
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In my view, many hedge funds are run by people who bring little to the investment table, other than bluster, and charge their investors obscene amounts as fees, while delivering sub-standard results, and it is the fees that make hedge fund managers rich, not their performance.
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The crowds that stormed the Bastille for the French Revolution burned the prison and killed the governor, but once done, they turned on each other.
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It should come as no surprise then that portfolio managers and market gurus are discovering that they no longer are the arbiters of whether markets are cheap or expensive, and that their path of least resistance might come from following what individual investors do, rather than lead them.
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Professional money management has always sold its wares (mutual funds, hedge funds, investment advice) as the products of deep thinking and serious analysis, and as long as the processes stayed opaque and information was scanty, they were able to preserve the delusion. In the last few decades, as we have stripped away the layers, we have discovered how little there is under the surface.
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During the last week, I have been asked many times how I plan to change the way I value companies, as a result of the GameStop story, and my answer is that I don’t. That is not because I am stuck in my ways, but because almost everything that is being talked about (the rising power of the individual investors, the ease of trading on apps like Robinhood, the power of social media investing forums to create crowds) are factors that drive price, not value.
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If the regulators have their way, it will get more difficult to trade options and borrow money to buy shares, and I have mixed feelings about the efficacy of these restrictions.