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Shorting sharpens long investing
Shorts in the deal flow
Berkshire does not short, but more than 200 acquisitions a year come across its desk. Depending on the market, in perhaps 10 to 20 percent of them the reaction is that the thing is a short, because most things are roughly fairly valued most of the time.
Reading both sides
JPMorgan's balance sheet shows why both sides matter. Read only the assets and two and a half trillion dollars looks amazing. Read only the liabilities and equity and two and a half trillion looks like a catastrophe. Short selling is the habit of reading both.
Why shorting is hard
Shorting is much harder than going long. A person can buy the S&P index, do perfectly fine, and never analyze a stock, and the short side has no equivalent. One rule of thumb is that a short seller has to be about 85 percent correct to make money.
That discipline keeps an investor from becoming myopic, dogmatic, or attached to a lazy narrative. It helps on the long side to identify compounders, weaknesses, and moats, and the answer falls wherever it falls.
Why is betting against a stock harder than buying?
A stock buyer's loss is capped at the amount paid, while a short seller's loss has no ceiling and the gain is capped at the stock falling to zero. Short sellers also pay fees to borrow shares and owe any dividends to the lender. Stocks also tend to drift upward over time. According to Morningstar's Ibbotson data, large US stocks have returned roughly 10 percent a year since 1926.
How do banks hold trillions in assets?
A bank's balance sheet always balances: assets equal liabilities plus equity. Most of a large bank's liabilities are deposits and borrowings, so it funds its loans and securities mostly with other people's money. That leaves only a thin layer of equity beneath the assets. Under the Basel III international standards, banks must hold common equity of at least 4.5 percent of risk-weighted assets, before extra buffers.
How did short sellers spot Enron early?
Jim Chanos of Kynikos Associates began shorting Enron in 2000 after reading its filings. He noticed that its returns on capital were low for a company with such a rapid growth story. In March 2001, Fortune published an article by Bethany McLean questioning how Enron made its money. Enron filed for bankruptcy in December 2001.
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