Dead Ends, Detours And False Starts

We do lots of research. The reality is that the vast majority of it finishes in dead ends, detours and false starts. From our vantage point, investing well is complex but certainly during this past decade, it has been far easier to make money as compared to other periods.

One of those cul-de-sacs was when Benj worked on a shorting system. He wrote in his best-seller, The Uncommon Investor, a contrarian guide to investing in the stock market, about the ongoing evolution of a method that he hoped would end up being very profitable. He did lots of paper trades to see if it might work. Believing it to be, he shorted Stelco, back in the day thinking that it would go bankrupt. Soon after the bet was made, four offers swiftly arrived to take over the company. The short was speedily covered, with about a 50 per cent loss in a matter of weeks. Ultimately, as Benj’s business partner Ben Stadelmann likes to say, “The operation was successful, but the patient died.” Stelco did go bankrupt.

Resuming testing with paper trades, an opportunity to short Pier One looked mighty eye-catching. Though tempted to play it for real, he did not. That was fortunate as the stock soon flew. The system was abandoned. Another dead end.

That does not mean that we don’t still salivate about shorting. Beyond Meat, Canada Goose and Kraft all had stock prices that seemed euphoric. They have had big drops. That does not necessarily mean that we would have made money if the game had been played. It is one thing to look historically at stocks’ numbers and say I could have made a fortune. It is another to actually buy and sell at major winning points.

While Benj threw in the towel, there is no question that shorters can make lots of money? One sector that appears very portly, is the major Canadian banks. All of these were throttled in the last downturn. Bank of Montreal fell to under $30. Now it tests the $100 level. RBC’s numbers are similar. CIBC was mid-forties, now around $110. TD was under $20; now cruising at $75. BNS under $30, now $75. In a recession, one would think that all of these enterprises will be cruising for a bruising.

One major problem of shorting stocks is that the short seller must cover the dividends if there are any. In this arena, there are healthy payouts that regularly increase. That makes the timing of doing the transaction more vital than when one goes long, as one must pay the piper every quarter. In addition, more collateral has to be put up if a loss is not covered. That is a difficult feature to pick up with paper trades!

Another key thing: the worst outcome for people going long on a stock is that 100 per cent of the investment is lost. While that is not, err fun, when one shorts the scope of the downside is not known. That makes it tougher to sleep at night.

That being said, while we believe that shorting every one of these banks could make money, it is not for the faint of heart. Thus, we’ll stick to our bread and butter buying contrarian plays that represent deep value. That has created a 18.4 per cent annualized return over the last 10 years. We can live with that.

Benj Gallander, MBA, Co-editor of “Contra the Heard”, Toronto, ON (416) 354-2458, gall@pathcom.com, www.contratheheard.com.