How Do You Short a Stock? What Does Shorting a Stock Mean?

So I have done this strategy a few times...a couple of times it worked out well and the other two...I am still waiting for my payday. But when I tell people in my office or my friends that I have shorted a stock, they sometimes ask me what that means, and other times I can tell they don't know what it means...so here is what is being done: So first off, when I say I am shorting a stock, it means that I am betting that the stock's price will fall.  So how do I bet that a stock will fall when shorting? Well, I go to my broker and I say, “Hey Mr Broker, I want to short 100 shares of ABC Corporation because I think it will fall below the current price of $50 per share.”  So what Mr. Broker does is he first looks and makes sure that my account can afford to lose big money because in shorting, as the price of the stock goes up, I lose money, so theoretically, there is unlimited loss potential. Once he has realized I don’t bet more than I can lose (usually), he puts the trade in for me. But what happens behind the scenes? Well, the broker finds other clients who have 100 shares of ABC Corporation in their portfolios and they let me borrow those shares from those clients and sell it on the open market at $50 per share.  So I, technically, get $5000 in my account when shorting, but I also owe $5000 to those customers who I borrowed their shares from.  The shares could also be the broker’s own in house shares, by the way. So I have a net $0 change in my account because I borrowed $5000 and then sold $5000 so the net asset change is $0. So now, if the stock goes DOWN in price from $50 to $30, I can then buy those 100 shares back on the open market for $3000 and replace the 100 shares I borrowed at the lower cost of $3000, so my net is $2000. Did you follow that? So I borrowed shares at $5000 and then replaced them at $3000, so I net $2000 in profit! And if the stock goes up, that’s how I lose money.  I borrowed those shares at $50 and I had to buy them back on the open market at $80, which means I spent $3000 more than I borrowed them at, so I lost $3000. Someone asked me once if that’s legal.  Ha.  Yes, it’s legal.  The bank, theoretically, won’t let you short more than you can afford to lose or anywhere close to what they have in their inventory of stocks. This is a very risky strategy if done without hedges in place.  But it can yield some high returns if done with the right timing…Which I haven’t done as of late....
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Amazon (AMZN): Killing Me Softly

Well f**k.  Amazon (AMZN) just announced that they made $92MM last quarter versus a loss of $126MM in the same quarter last year.  So what did investors do?  They decided to reward Amazon with an $85 per share increase after hours.  That's an additional $40Billion or so in value added.  So now they are officially worth more than Wal-Mart.  And that is beyond stupid...and here is why: In the last twelve months (TTM - Trailing Twelve Months), Wal-Mart has $485Billion in revenue.  Amazon has $96Billion in the last 12 months.  So Wal-Mart, by sales, is 5 times larger.  But it is worth LESS?!?!?! Ok...maybe it's about profit... In the last twelve months, Wal-Mart has made $16Billion in net income.  Amazon has LOST $188MM.  Wait.  So Wal-Mart has MADE A PROFIT of $16Billion and Amazon has LOST $188,000,000....LOST....Oh but wait, everyone says it's about the growth... I know.  So Amazon's BEST argument is that they are investing in more and more things to make the experience for users better and grow their media collection and blah blah blah.  Ok. Fine.  Then why can't you make money off of $96B EVEN DOING THAT?!?! Their best margins ever were almost 4%...Wal-Mart, which is brick and mortar and supposed to cost more, is higher on average.  So let's assume that they hit 4% in profit margin in the long run because of their investments and they finally start to turn a profit...on $96Billion in sales, that's profit of $3.8Billion. So at a market cap of $265Billion, that's a price to earnings ratio of 70 still! Which is still 5 times more than historical averages especially for such a mature company because REMEMBER, Amazon is  a MATURE company. It isn't a start-up! It's been around for 20 years! Sure it is! They surprised everyone by growing 20% from last year's same quarter.  Ok. So let's assume they continue to grow 20% per year and let's assume Wal-Mart only grows at 3% per year...how long will it take for Amazon to catch up?  Remember, assuming 20% growth per year is HIGHLY unlikely...is it impossible? No.  But even Amazon's growth since 2007 has slowed significantly.  From 2007 to 2008, before the big recession, Amazon's revenue grew 30%.  So there is going to be a slow down.  Have they had better years since then?  Sure, but here is their year over year growth since 2007: 30%, 27.9%, 39.5%, 40.5%, 27%, 21.9%, 19.5%, and this last quarter they SURPRISED everyone with 20% growth. So back to my point: Let's assume 20% growth for Amazon every year and only 3% for Wal-Mart every year...In 10 years, Amazon's revenue will be $595Billion and Wal-Mart's revenue will be $651Billion! They still haven't caught up to Wal-Mart! And even at $595Billion in revenue and 4% profit margin, which I remind you they have never achieved, they will have profit of $24Billion which is still only 10 times earnings of TODAY'S MARKET VALUE!...which is about where stocks should sell for during a bad bear market.  So let's even assume that it should sell for the same multiple as Wal-Mart, which is around 15 or so historically. That's a valuation of $360Billion which is 35% higher than today. Soooooo...follow me here...Today's market value of Amazon is 35% lower than what it should be if it were to grow at 20% per year for 10 more years AND have profit margins it has never seen before.  Does it sound optimistic?  Absolutely.  Yes, Amazon is winning the popularity contest right now, but no companies does that for decades.  Microsoft didn't. Google didn't.  Dell didn't. IBM didn't.  No one does.  And sometime in there, it will massively correct.  And when it does, it will be ugly.  Until then, my bank account looks ugly. Good day....
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Why Does The Stock Market Keep Going up?

I have no f**king clue.  Well, I have an idea, but it's stupid and illogical.  Everyone says that they need returns because gov't debt for 10 years only pays 2.2%, so why not invest in the market and get a 2% dividend and see it grow 10% per year? #Stupidity So this means you should pay ANY price because it's better than making 2.2% with the US Gov't for 10 years?  Of course someone would say "Well, no not ANY price" but when we have valuations almost as high as 1999/2000, to me, it means almost any price. Today on Yahoo Finance, the front page had a picture of a woman throwing money in the air and the title was referencing how one trader thinks we have 2.5 more years of bull market.  Forget that we are in the second longest streak of days of stock market without a 10% correction (1340+), he is thinking we have over 900 more at least.  I'm not saying he is going to be wrong, because I have been wrong so far, but we have Europe really struggling, not a lot of corporate profit growth, massive amounts of U.S. debt, and profit margins sitting at DOUBLE the historical average....these things don't bode well for market tops, but then again, I have been wrong for over 2 years now. Also, back to Greece.  Jeeezzzzz.  We are happy because Greece may get a deal and avoid insolvency for a bit longer?  Why is that something to celebrate? I created an analogy today that my investing compadre thought was spot on.  This Greece situation is similar to committing murder, admitting to it, the police having video footage of it, your lawyer telling you that you will do time, and yet, everyone celebrating your freedom because your lawyer was able to push back sentencing for 3 days for whatever reason.  You're not free!! You're still going to go to jail! You just pushed it back 3 days! That's it! Greece WILL FAIL! Maybe not tomorrow...but it will fail.  The problems are fundamental...they don't have increasing revenue and they are in a severe depression with 27% reported unemployment and GDP per capita down 33% in the last 6 years. Yes, there are always things that can cause markets to go up and down and no, I don't just dwell on the bad ones.  I just look at history and see what the most fundamental drivers of wealth creation are, and we have none of them right now.  We don't have low asset prices relative to history, we don't have increasing earnings, we don't have increasing GDP and jobs, and we have barely had any income growth in this country that would drive the rest of this! How can we celebrate the stock market?! Onward and upward Mr Stock Market....
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Should I Tell My Kids How Much I Make?

I just saw a Yahoo Finance article that said that only 17% of people who make over $100,000 per year tell their children how much they make, with the most common reason being "it's none of their business."  I don't know how much I agree with this. My father was very open about money to us when we got into high school. We knew how much he made and how much he spent and he talked about frivolous spending frequently.  My mother is still a bit shy in discussing it, for some reason. So this can go both ways. If you make A LOT of money and you think it could cause problems with your kids knowing that much money due to ego/arrogance/being spoiled, I can understand that concern, but is that really because of how much money YOU make or because your kids may already be spoiled and there was an issue raising them?  I am not trying to throw stones, but there are plenty of good kids that come out of very wealthy families and plenty of bad kids that come out of lower income families. I am a BIG believer in being open about money at an early age so it can show your kids what it takes to live certain lifestyles. If you don't make a lot, it will show your kids the limitations of money and when you aren't able to provide certain things, it shouldn't be a cause for embarrassment but more of a reason to talk to them about why they may want to take more risks or go get an extra degree in school in order to achieve higher income. If you make a lot of money, your kids will see that it takes a lot to live a nice lifestyle and to get the things they will want later in life and the security of retiring at a younger age. The bottom line is that if you raise your kids the way you should by valuing a dollar no matter what your income is, they will learn to appreciate that income level.  I know that I am a big saver and conservative with investing because I never want to sacrifice the lifestyle I have grown accustomed too.  Has that inhibited my risk taking? ABSOLUTELY! Do I regret that? Absolutely not. I just have to find other ways to make above average returns other than taking undue risks that could sacrifice what I had the good fortune to be able to build on. Don't be scared to show your kids what you have. It's a great way to teach them.  Everything can be made into a good situation or a bad situation: take whatever situation you are in and use it as a learning tool for your kids.  The kids I know whose parents were very tight about their information grew up to resent the lack of trust their parents had with them....
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My Investing Ego Is Worried About Tomorrow More Than Today

As we progress down this road of massive overvaluation and incredible arrogance of not seeing what history has proven time and time again, I am, unfortunately, finding myself getting heated over what the future will hold...not because there will be massive decreases in stock prices and money will be lost...quite the contrary.  When that happens, I will do quite well.  What bothers me is that the same people who think that I am wrong today are the same ones who will say how obvious the overvaluation was...the same people who say that about 1999/2000 and the real estate bubbles in the mid 2000s. The reason this is causing me worry is that these are the same people who are ignoring the advice of today.  In the world of valuation, the levels we sit at today are so beyond obviously overpriced that it hurts to even think about how the justification can be made for current stock prices.  Financial memory, according to Galbraith, is 4 years and that is quite apparent today.  Everyone forgets 2000 and 2008, and everyone most certainly won't even look at data going back to the 1940s with 90%+ correlation.  Why?  It's not fun to see what the past has shown and what the future could very likely be. It is a matter of ego.  Part of the reason I started this blog was for ego purposes.  Yes, I have been wrong as of late, but when the markets start to do what is apparently obvious over the next 2-5 years, I will have the ability to say "not only did I think it, I said it."  Is that mature?  Absolutely not.  But it's no less mature than not looking at data and history to see what has been undeniable for decades. A man I write a lot about, John Hussman, quoted his works from 2000 when he wrote this about the NASDAQ and S&P 500..."

It’s instructive to look back on the comments that we published in 2000 as the bubble, in hindsight, was about to burst:

“The issue is no longer whether the current market resembles those preceding the 1929, 1969-70, 1973-74, and 1987 crashes. The issue is only – are conditions more like October of 1929, or more like April? Like October of 1987, or more like July? If the latter, then over the short term, arrogant imprudence will continue to be mistaken for enlightened genius, while studied restraint will be mistaken for stubborn foolishness. We can’t rule out further gains, but those gains will turn bitter… Let’s not be shy: regardless of short-term action, we ultimately expect the S&P 500 to fall by more than half, and the Nasdaq by two-thirds. Don’t scoff without reviewing history first.”

- Hussman Econometrics, February 9, 2000"

The NASDAQ ended up losing 78% by its low and the S&P lost about 50%, as he said they would.  Yes, it took some time to get to those points, but once it did, it was ugly and he called it.

Many don't realize that this kind of analysis does not take excessive time.  Keeping it as simple as possible is the best way to eliminate confusion and error.  Investing in equities is purely an analysis of what you believe your profit to be over a certain amount of time based on risk and potential reward.  Right now, the risk is too great for not enough reward on a time horizon of 5-10 years.  Will it go bad today or tomorrow? Who the heck knows?

As I told my Bloomberg sales rep the other day and I repeat very often to others "Bull markets make the Average Joe look like an investment genius."  It's easy to say things will continue going up because if they don't, everyone else lost too, so you're among a large company of bad investors.  If it continues to go up, it's easy to say "See, I told you." The question becomes not how well you do when everyone else is doing well but how well do you do when everyone is losing their shirt.

I will continue to look dumb and feel the bruising of my ego for a bit longer, but one day that will change...and I will talk about how great equities are and valuations are so good while others are saying "Stocks are the worst investment to be in." Trust me, that day will happen.  And when it does, you need to start buying because that is when fortunes and wealth is created.

...
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These Markets Are Making Everyone Look Brilliant…except Value Investors

Markets keep going up.  Everyone keeps getting more and more confident in the markets.  It's now to the point where when I hear someone say "Boy, this market is overpriced", what they typically mean is "This thing is gonna fall 5-10% and it will be a great buying opportunity."  Hardly the sign of overpriced.  That's a run-of-the-mill market pull back during normal markets. I am not a believer in that just because something has gone up for so many years does it mean it's overvalued.  What makes something overvalued is that it is selling at a level that, based on history and fundamentals, is well above the normal range of valuations.  We are at levels, right now, that historically will produce break-even results INCLUDING DIVIDENDS over the next 10 years.  This historical accuracy is around 90%, based on John Hussman's Weekly Market Commentaries.  This means that 10 years from now, we can expect the S&P 500 and Dow Jones to be 20% lower than they are today, on a nominal basis.  This is also the valuation metric that Warren Buffett has said is probably the "single most accurate measure of stock market valuations at any given time." Since 2000, we are only up 43% or so on the S&P, not including dividends.  That's a mere 2.4% annual growth rate on the S&P 500, but what you need to remember is that valuations in 2000 were at all-time highs compared to history and we are NOW at valuation levels that are merely 10-15% lower than 2000.  Everyone thought that the markets would keep going up back in 2000 and 15 years later, we have only seen 2.4% capital growth on any dollar invested in the year 2000.  So let's not forget that valuations DO matter.  There is a capitulation point for every market, good or bad.  No one remembers the bad times when things are good and no one remembers the good times when things are bad. Could the party end again? Of course...and it will. When?  No idea.  I've been calling for it since 1500 or so on the S&P...that was many moons ago, and I admit that I was trying to fight momentum. In late 2008 and early 2009, I was one of the few positive investors out there.  A lot of people have said "But you used to be so positive on the market! What happened?" Valuations happened.  My views on the market are based on historical valuation metrics that have proven to be highly accurate over time.  Clearly my timing has been off, but over the long run, these will prove to be true.  There will be a time in the next 5 years where I will be one of the few bulls out there talking about the incredible buying opportunities and low valuations.  Yes, when I make those calls, things will likely get worse and people will question me then like they question me now...but historical returns will eventually take grip then and a new secular bull market will take hold. Unfortunately, this is all part of the process.  The excesses of 1982-2000 were so large that it will take a few ups and downs in the market for people to give up on stocks and, only then, will a new secular bull market be ready to take force. I will wait patiently until valuations are at the right levels.  I have no idea when that will happen, but when it does, you will be able to read these posts and see that sound value investing can make someone look stupid for a while but brilliant later on.  I'm not hoping to look brilliant at the expense of others, but I am writing these words and showing that I will be putting my money where my mouth is....
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What is a Value Investor?

I was just on CNNfn.com and I came across an article by Scott Fearon, CFA.  He is discussing what we can learn about investing by looking at the death of pay-phones (http://cfainstitute.tumblr.com/post/111879028236/what-investors-can-learn-from-the-death-of-the-pay). His point, in a nutshell, is that back in the last 1990s, he received "Buy" recommendations from analysts about inexpensive pay phone companies but they were inexpensive because they were a dying company. Now those are penny stocks, if they even exist. He said the value investor who cares about those metrics miss the forest for the trees...hmmm. I don't disagree, much, on that point about why pay phone companies were a bad buy in the last 1990s.  However, I would make two points.  1.) Most EVERY company that wasn't a high tech high flying company was ignored in the late 1990s and had lower valuations.  Unlike today's market, small and midcap companies were actually reasonably priced even during that late 1990s boom because the overvaluation was centered on high tech highly valued companies.  2.) He has no idea what a true value investor does. Scott goes on to point out that value investors need to care about growth.  Uhhh.  We do.  That's what he is missing.  A true value investor isn't just looking for a "cheap" stock.  They are looking for an ignored stock or company, for whatever reason. Last year when I was buying Microsoft like crazy in the $25 range, everyone was telling me how stupid it was because Microsoft was dying...yet when I looked at their yearly revenue and profit numbers, every single year they were growing.  So here was a GROWING company who everyone was ignoring because they weren't sexy anymore and therefore was selling at 8-9 times earnings. THAT is value investing.  I didn't buy Radio Shack when it was dying.  I didn't buy his example of JC Penney because it was dying and a true value investor isn't looking for dying businesses.  They are looking for OVERLOOKED businesses. Ironically, we see an article like this during a major bull market and at a time when valuations are through the roof.  I get it.  It's easy to dismiss value investing when things are going gang busters.  Ironically, the best investors of all time tend to be value investors and they tend to do best when markets are dull and down.  That's when they get the best deals.  When the markets are so far down that people don't even want to buy the good companies at good prices, that's what a value investor is looking for. Not the dying companies when markets are going great....
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Patience Is A Virtue I Normally Do Not Possess

2014 finished in a way that was quite disappointing.  In terms of the stock market, I have missed out on the majority of the gains in the S&P 500 since it was at 1500 or so and I have even bet against Amazon and the entire market along the way.  Clearly I have missed the mark. I was just scanning Yahoo Finance and came across an article where Bill Ackman is announcing that he is in the money on his short of Herbalife.  If you are not familiar with the story, please take some time and look into it.  Ackman shorted the company by calling it a "Ponzi Scheme" as many reputable investors (Carl Icahn and George Soros) praised the company and bought shares in it.  The stock climbed from the $30 range all the way up to $82 per share, and I believe he had lost about $1Billion at that point. But he kept insisting he was right.  EVERYONE said he was wrong.  He said "Nope, i'm right. You're wrong." Now, granted, the stock isn't done yet. It could bounce right back up but right now, he is not only making money but he also feels vindication I am sure. I've been shorting Amazon (AMZN) for over 2 years now and have been "wrong" because the stock is above my original short price.  I've shorted the entire market as well and so far, I've been wrong.  But there are bright spots.  Amazon went from a high of $408 and now it's sitting under $290.  Not quite the darling it was just a year ago.  The stock market, overall, has had many jumps and falls over the past six months which are typical during the topping process. I hope, and I'm confident, that I will end up being right, but patience, my most lacking virtue, is what I need to stick with and what most investors have a problem with.  We need patience.  In my other businesses, I want things done yesterday, but with investments, you have to give the time to let things pan out if your analysis is correct.  Even then, you will be wrong sometimes. Everyone forgets the tough times during the good times and the good times during the tough times. That's why sound financial analysis is important at all times.  Be patient for the opportunistic times because that is when true wealth is built....
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Antoine Walker Went Broke – And He Blames Investing

Antoine Walker is well known for making $110MM playing basketball in the NBA and recently filing for bankruptcy.  Flat broke. Doesn't even own a car in his name.  He has come out and been open about what happened and what he went through, which I very much respect and love to hear...but a bit of me has lost some respect for that story. What I am about to say DOES involve some assumptions, but I want everyone to focus more on what my overall message is about what happened to him. If you read this article and the video in it (http://finance.yahoo.com/news/former-nba-star-antoine-walker--life-after-losing--110-million-214644672.html), he talks about his spending but during it, he also says that what really made him go broke was "bad real estate investments."  But look at the other things that were said about his spending.  Multimillion dollar homes for his family members. Not one family member..but many. Flying around in private jets with 9 or 1o of his friends.  Losing millions in gambling at casinos.  Buying four or five cars for each house he was at.  Yes, real estate was probably the final nail in the coffin, but he was on the path to going broke LONG before that.  And then he blamed the real estate bubble that so many didn't see.  I get it.  We don't always see those things, but not because we don't see them...we aren't looking for them.  I won't even get into that right now... My point is, he spent like crazy and made some bad investments.  Even if his investments did well, was it likely that his spending would have been able to keep up? I don't know but I seriously doubt it.  He made $110MM, but after taxes and agent fees, that's $55MM.  He owned four or five multimillion dollar homes, so that takes about $20MM out of that number.  And when you lose millions gambling and then how much more does it cost to fly private jets and take 9 or 10 of your buddies on every vacation you go on as well as buying expensive gifts for all of them...you can do the math. Bad investments can always cause a lot of problems. I would never minimize that fact. But to say it was what is what he really did wrong? I think that's denial and try to run away from the all too common problem that athletes have...they just spend too much money....
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Speculator vs Investor…again

I have written about this topic in the past and it is a constant sore subject for me.  Meeting many financial professionals is humorous because of their quickness to discuss how "financially minded" they are and all the "hot stocks" they are kicking ass on.  When I ask the simple question of "Why did you invest in that?" it can tell a lot about whether the person is an investor or a speculator. You, as an "average" person, can easily find out which financial advisor is right for you by asking the simple question of "why?"  If the answer sounds like b.s., it probably is.  If they can't explain, in normal terms, why an investment is worth it, it probably isn't.  I am reminded of Enron and how the CEO and President couldn't explain how they made money, and looking back, THAT is how everyone should have known it was a fraud. The same way a CEO should be able to explain how they make money, your financial advisor should be able to easily explain why you are in a specific fund or stock.  If they can't, run for the hills. After all, you can easily beat the stock market over time by just buying dividend paying stocks in the S&P.  It has been proven time and time again that just buying the dividend paying stocks in the S&P will beat the S&P handily over time (2%+ per year).  Why pay fees to someone who can't explain basic fundamentals of investing to you when you can just invest on your own and beat the market? Don't be afraid to question.  When I get asked questions, it makes me happy that someone is basically asking me to prove I know what I'm talking about...everyone who has knowledge wants to show off their knowledge.  If they don't have knowledge, they will get defensive and not be able to show you.  That will also be how you know they are a speculator vs an investor.  A speculator is someone who doesn't have a basis for making decisions and they are basically just throwing darts at a board.  Can they be right at times?  Of course! During any bull market, like the one we are in now, anyone can look brilliant.  But those who follow the trends will lose when the trends fall out of favor, which happens when markets turn and it gets ugly.  Don't follow that person.  It can be hard, though, when the herd is your buddy at work or your neighbor bragging about their 35% gains last year. Oh, and the stock market is still vastly overpriced.  Still waiting for my 40-50% bear market. In case anyone forgot.  And if you asked me why I think that, I would have many logical answers.  Because I'm not afraid to have the answers....
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