In 24 years of investing, I’ve tried pretty much every get rich quick scheme there is. One of those is shorting stocks, which sounds great in theory, but like most things on Wall Street, it is far harder to pull off well.
This is why I wanted to warn investors, during what might be a trade war-induced pullback/correction, that there are three reasons why shorting stocks is a dangerous strategy that’s likely best avoided.
Reason 1: The Market Can Remain Irrational Longer Than You Can Remain Solvent
I understand why shorting can seem so appealing. Borrowing shares of a company from your broker, selling them and then buying them back at a lower price can seem like a “sure-fire” way to make money, especially on some companies.
For example, Tilray (TLRY) a red hot cannabis stock in 2018, got into an obvious bubble, when it peaked at about $200 in 2018, a mind-boggling 650 times sales and a market cap of $20 billion (more than American Airlines).
It’s since crashed 80% from those lofty highs, and theoretically, short-sellers who timed the top could have made a handsome profit.
Or how about Beyond Meat (BYND) which soared almost 10 fold from its IPO price just a few months ago? This is a company that’s still losing money but recently hit a peak price to sales ratio of 120 and a $13 billion market cap. All for a firm that owns just two patents (has no moat), and is facing multi-billion dollar food rivals all planning on launching competing meat replacement products.
Or how about shorting an “obvious” victim of the “retail apocalypse” Simon Property Group (SPG) the largest mall REIT in America?
First, let’s address the case of bullish bubble stocks, and then I’ll explain why shorting dividend stocks is also a potentially bad idea.
As economist John Maynard Keynes explained, “markets can remain irrational longer than you can stay solvent.” Shorting stocks involves leverage (you have to borrow shares from your broker to sell and then repurchase at a hopefully lower price later). And as the Tilray and Beyond Meat bubbles show, there is no telling how irrational or how high “red hot” hype stocks can soar.
Beyond Meat was “obviously” overpriced at $50, and more so at $75 and outlandishly so at $100. Yet it managed to rise to over…