Business Week's guest on Aug. 4 was Gary Weiss, associate editor of BW, to talk about his Aug. 5 Cover Story on the secrets of short-selling -- selling borrowed stock in the hope of replacing it at a lower price and pocketing the difference.
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OnlineHost: Welcome to Business Week Online! Tonight's topic is the secret world of short-sellers in the stock market -- do they have a bum rap? Our guest is Gary Weiss (GARYW BW), associate editor who wrote the Aug. 5 BW Cover Story arguing that the shorts may not be all bad. The moderator is Jack Dierdorff (JackBW), consulting editor of BW Online.
JackBW: Good evening to all of you on AOL. Welcome, Gary Weiss of BW.
GARYW BW: Hi, Jack!
JackBW: Gary, let's start by asking you to tell us the conclusions you came to about short-selling in the Cover Story you reported and wrote for BW (Aug. 5 issue).
GARYW BW: Well, I came to the conclusion that it can be pretty nasty sometimes but that the people who own and promote stock can be pretty nasty, too! So what you have is a situation where a small number of shorts -- not always the nicest people -- are counteracting what is basically an ocean of hype on Wall Street.
JackBW: Let's back up for a minute and have you define short-selling for the layman.
GARYW BW: Well, that is a bet on a stock price declining. You do it by selling stock that you do not own. The mechanics are a bit complex, but the principle is simple.
JackBW: Walmarc sent us a number of questions ahead of time. Here's the first one.
Question: What portion of an individual investor's portfolio (if any) should be allocated to shorting stocks?
GARYW BW: I would say none! The problem is that short-selling is too risky. Your downside potential is unlimited, and your upside potential is limited. Also, you can get "squeezed" by stock promoters.
Question: Can you recommend any books or newsletters that would give advice on selling stocks short -- and which stocks to short?
JackBW: Or is the answer the same as your last one: This is a game for the experts?
GARYW BW: It is a game for the experts, but there is no harm in reading about it! There are a couple of costly newsletters, Overpriced Stock Service and Short on Value. No, I don't have their phone numbers.
Question: Can you give us some recent examples of short-selling that made the news?
GARYW BW: There have been a few recent examples of people who own companies accusing short-sellers of pushing down their share prices. For example, Diana and Solv-Ex, two of the companies I mentioned, and also a company called Biovail recently sued a short-seller.
JackBW: CA FLOOD sends us this question from San Francisco.
Question: Isn't corporate (read investment broker) short-selling an organized scam by brokers anyway?
GARYW BW: I'm not sure what you mean by investment broker short-selling. A lot of brokers go short just in the ordinary course of business. I think there are a lot of organized scams among brokers, but they are mostly on the "sell side."
JackBW: The next question comes from StJohn609, near Philadelphia. Someone else also asked about the differences between shorting and trading options.
Question: Are you talking options or the underlying stocks?
GARYW BW: Trading options -- that is, buying "put" options -- is much less risky than short-selling the underlying stock because all you can do is lose the price of the option.
JackBW: TRSURHUNTR wants a few more details about such transactions.
Question: How long can a position be open, and what are the costs of such a position on a daily basis to the short seller?
GARYW BW: You need to open a margin account. Then you put up marginable securities, and that is the collateral for the short sale. If the price of the stock you short-sell goes up, you have to put up more collateral pronto or the broker will buy back the shares.
JackBW: Westrgrd has a question about your story in Business Week about short-selling.
Question: Gary, your article doesn't address the issue of short-sellers circulating false information.
GARYW BW: No, I mentioned the one recent instance in which shorts allegedly circulated false information. That was Organogenesis, a story BW broke a few months ago. However, what I found was that while companies often complain about shorts circulating false information, it is rare. And, in fact, I could not find any recent instance where it was proven in court.
JackBW: In fact, Gary, didn't you point out that often shorts alert us to bad investments?
GARYW BW: Yes, and if false information is circulated about a company, the company can't be too unhappy because if markets are efficient, the stock price will bounce back when the truth comes out and the lie is disproven.
JackBW: WWTP ENGR in Nashville wonders about selecting stocks to short.
Question: It seems like people want to be told which stocks to long or short instead of taking the time to do research. How do the "experts" choose, and what research tools do they -- the experts -- use? Do you need to have an MBA in finance and be an investment banker to choose correctly?
GARYW BW: Yes, I think people rely too much on experts and newsletters. They should do what the shorts do for ALL their investments -- do their own "due diligence." Don't take anybody's words for it. Research tools? They are too many to list -- trade magazines, first-hand research, the Internet, and the stock boards here on America Online, among other things.
JackBW: Now, from Eagle24 in Brielle, N.J.
Question: Are short-sellers more prone to take active roles in IPOs and secondary offerings?
GARYW BW: It is very tough to short IPOs. They are very, very difficult to borrow. But often the underwriters themselves short the stock.
JackBW: Steeda5997 in Chicopee, Mass., has been watching the news.
Question: How about the recent ValuJet scenario? Wouldn't that be a worthy situation to short out?
GARYW BW: Well, you would have had to have shorted the stock, as I understand it, before the plane crashed! Implying a peculiarly sinister form of inside information.
JackBW: MULUTOY pops us this one.
Question: It seems like many stocks have at least some short interest. What percentage of outstanding shares do you consider to be a significant short interest in a stock?
GARYW BW: Depends on the daily trading volume. Some stocks have vast short interest -- such as Iomega, which has I think over 20 million shares shorted, or something like that. But on some days its trading volume is over a million shares.
JackBW: Here's a question from Walmarc again.
Question: Can you describe how a "naked short" works?
GARYW BW: Well, it is not as obscene as it sounds, though it is viewed very negatively by lots of people. Basically, it means selling short stock without borrowing it or finding out if it can be borrowed. Some brokers go "naked" as part of their market-making functions. But it is illegal to be a naked short to bet on a stock price declining.
JackBW: Samnites in Stony Point, N.Y., asks where to start.
Question: Could I go to any broker to do this?
GARYW BW: To sell short, all you need is a margin account. And believe me, any broker would be all too happy to get you one.
JackBW: But you did point out earlier, Gary, that you don't think short-selling is for the average individual investor.
GARYW BW: No, but people may disregard my advice and sell short. Believe me, if they want to do so, it is really pretty easy.
JackBW: Try this one next, from Lark8888.
Question: You said that there are a lot of scams by brokers on the sell side. I suspect that a stock I own is involved in one of the scams. How can I find out if it is?
GARYW BW: Well, at the risk of sounding self-serving, you can give me a call and talk to me about it! 212-512-2974 -- I am not kidding. Or you can call NASD [National Assn. of Securities Dealers]. But call me first.
JackBW: Sam L 11 is the questioner now.
Question: Are stocks with very high price-earnings ratios good candidates for short-selling?
GARYW BW: There are no hard-and-fast rules, particularly when it comes to p-e ratios in today's market. There are lots of stocks with high p-e ratios that will have high p-e's for a long time to come.
JackBW: ThePointer asks about shorting foreign stocks via American Depositary Receipts (ADRs).
Question: What is your feeling about ADRs vs. ordinary shorts?
GARYW BW: There is no difference whatsoever that I am aware of, at least. The difference is only that you are dealing with a company that is overseas and may use accounting or what-have-you that you and I would not understand.
JackBW: Several people are asking about specific stocks that might be candidates for short sales.
GARYW BW: Sorry, we don't recommend.
JackBW: Business Week cannot give advice on specific stock issues.
GARYW BW: Exactly! People should do their own homework anyway.
JackBW: TEATHANAS in Michigan sends in this one from his keyboard.
Question: Don't you have to know a company at least as intimately to short it as you do to invest in it?
GARYW BW: Yes, I agree. In fact, you need to know a company a lot more intimately, because your risks are limitless and because you can be "squeezed," so you have to know a bit about the kind of people who run the company and own the stock. If they are not exactly Boy Scouts, the company may be a great short in theory, but it may subject one to an awful short squeeze.
JackBW: Sam L 11 brings us to an important point.
Question: Are price upticks always necessary to short?
GARYW BW: There is something called the uptick rule, which means that the last price change in the stock must be an increase before it can be shorted.
JackBW: A question from CactusSlim in Tucson now.
Question: How does one avoid getting caught in a wildly overoptamistic market such as we had in April? Even if obviously overvalued stocks were shorted, they kept going up to even greater heights before crashing. Presstek«MDNM» comes to mind.
GARYW BW: That's a good question, because there is nothing whatsoever you can do to keep from getting caught in a market updraft if you are short! You could be shorting some of the world's lousiest companies, but if the market is going nuts, you are going to be creamed if you are short.
JackBW: Westrgrd returns with this one.
Question: Isn't it important to note that short-selling has been a massively losing business in the '90s as momentum has become a dominant market force? The fact is that the Feshbachs were wiped out. And they definitely did pass around false info -- I saw it happen.
GARYW BW: Well, it is true that the shorts -- and the Feshbachs, in particular -- have been losing money hand over fist. As I noted in the article, the average investor in a short-only fund lost about half of his investment over the past six years.
JackBW: Rbs1996 has a question about a specific stock we might be able to address.
Question: Is shorting Iomega contributing to its declining stock price, or does it not affect it?
GARYW BW: I don't have any firsthand knowledge about that, but I understand that what you have seen is some massive dumping of Iomega by institutions. Institutions have no restrictions on their stock sales, but short-sellers do.
JackBW: On mutual funds next.
Question: How about mutual funds that short?
GARYW BW: A lot of mutual funds are permitted to go short, but very few actually do so. Usually they are "contrarian" funds, and they have not been standout performers. Funds that sell short are subject to tax consequences.
JackBW: Victorialm asks next.
Question: Is it ever reasonable to short a stock that you are long in, if you are uncertain of its future direction, with the intention of closing one or the other position as things become clearer?
GARYW BW: That's called "shorting against the box," and I think it makes more sense to hedge with options, if you must.
JackBW: BRIANURBAC wants another definition that could be helpful tonight.
Question: Would you please explain a short squeeze?
GARYW BW: That is basically being short in a stock that is rising either because of market forces or because someone is hyping or manipulating the stock upward, or forcing shorts to deliver stocks they've borrowed.
JackBW: Next, from Jukebrotha.
Question: What is a prime technical indicator that would influence one to short a stock?
GARYW BW: I'd argue that there aren't ANY technical indicators that should influence any individual investor to short-sell a stock. Also, I never heard of short-sellers making very heavy use of technical indicators.
Question: Do short traders use computerized programs, as do option traders?
JackBW: Witching hours for the shorts?
GARYW BW: Short-sellers tend to use fundamental research and not technical indicators -- charting and so on -- though there are probably some technicians who short stock. But I don't know of any "short-only" funds that use charts and computer programs exclusively.
JackBW: One final question, from RsteveVis in Visalia, Calif.
Question: Is it possible to short Indexes such as the S&P 500?
GARYW BW: Sure, you can buy puts on the S&P index, and you can also short the S&P baskets that are sold by, I believe, the American Stock Exchange. You can short the indexes via either futures or options. Options are the best bet.
JackBW: Thanks, Gary Weiss of Business Week, for your knowledgeable answers on the world of short-selling in the stock market.
GARYW BW: My pleasure!
JackBW: Thanks also to the many AOL members who supplied questions -- sorry we didn't have time for more. Transcripts of this and all BW Online conferences are available soon after the event. Look under Talk & Conferences on the BW Online opening screen. Thanks again and goodnight, all!
Copyright 1996 by The McGraw-Hill Companies, Inc. All rights reserved.
