I recently heard one of the most famous morning talk show hosts on the radio insist that, following the recent events surrounding the video game distribution company Gamestop (and others, including Spain’s Tubacex), not only such coordinated actions via social media should be banned, but also short selling. The Uber driver who took me to the office nodded insistently as everyone in the conversation criticised the funds and investors who engage in “shorting” stocks.
Regardless of all the controversy surrounding Gamestop, Reddit group WallStreetBets and broker Robinhood in recent weeks, it never ceases to amaze me how the general public has such a negative image of bearish investors.
Firstly, people are unaware of the important role they play in the stock market. By borrowing shares to sell them and then buying them back at a lower price, in many cases these investors help to improve the efficiency of price formation, i.e. they help to bring prices closer to the company’s true value, and thus act as a counterweight to financial bubbles forming.
In addition, many of them do extensive, almost forensic, research on the companies they sell, often helping to expose poor management teams and uncover fraud. I’m sure you remember the Spanish company Gowex, which ended up being a scam brought to light by one of these bears, Gotham City.
Does this mean that we should not invest in companies with bearish positions? No, because these investors, like anyone else, make mistakes. But their role in the markets is undeniable.
And something we are often asked is: just as we buy companies that we believe are undervalued, why don’t we short companies that we believe are overvalued?
The main reason is that selling shares short is much riskier than buying them. And as is well known, at Cobas AM we are very conservative with our money and that of our unitholders. By buying undervalued stocks, i.e. with a large safety margin, the risks we take are very low. And if we are wrong, we will lose 100% of our investment at most. What happens in the case of short selling? Quite the opposite. If you are wrong, the losses are potentially unlimited, as the share price could rise indefinitely.
However, as we always like to say: “Let the cobbler stick to his last”. We know how to do something very specific, which is to try to buy good businesses that are trading below their intrinsic value and sell the shares when the price is close to that value. I believe that shorting would take the Cobas AM team outside our circle of competence.
Finally, we could say that there is a much more subtle and somewhat more philosophical reason why we do not trade bearishly, and that is simply that we prefer to “bet” that things will get better. In other words, we prefer to benefit when things are going well, in short, be optimistic.
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