Chas Craig, BridgeTower Media Newswires
Regular readers may recall that late last fall we revealed a short position in National Beverage Corp. (FIZZ). We felt prompted to share our thoughts about a 10/19/17 press release by Nick A. Caporella, CEO of FIZZ. His scathing and arguably, often not fully lucid press release was in response to the greater-than-20-percent decline in the company’s share price from its then recent September high.
Caporella’s rant covered a lot of ground. The primary rub was that stocks don’t trade on fundamentals, a claim for which he provided figures that were as precise as they are unverifiable. More specifically, he complained that “perpetrators” had been “stating falsehoods” to manipulate FIZZ’s share price to achieve ill-gotten short selling (selling borrowed shares with the aim of buying them back at a lower price) gains. He went as far as to urge SEC action against short sellers. Given the venom Mr. Caporella directed toward the short-selling straw man he had erected, we thought he and others could benefit from reading a summary of our research conducted at the end of September 2017 that served as the fundamental basis of our short position initiated at that time.
Fortunately, we covered (i.e. closed out the short position via buying back the shares we had sold short) in mid-March, realizing a 25-percent gain. However, our decision to cover the FIZZ short was not a result of believing FIZZ to be an attractive investment at the mid-March price. Meaning, while we bought FIZZ shares to close a short position, the share price would still need to go much lower before we would consider buying it to own it, all else equal.
Below are the two primary reasons we think investors should be rationally inclined to cover short positions more hastily than they would sell a long position.
(1) There is no upper-bound for a company’s stock price. While upside is theoretically infinite, from a practical point of view, it is not uncommon for share prices to rise by more than 100 percent over a reasonably short period of time. By contrast, the ultimate gain that can be realized on a short sale is 100 percent (i.e. stock prices can’t go below $0). Generally speaking then, there is an asymmetry in the probability distribution of returns for any given stock that puts the odds of success on the side of long investors.
(2) Selling stock short can be costly. If the company of which an investor has sold shares short pays a dividend, the short seller must pay the dividend to the holder from which they borrowed shares (this process is administered by a custodian such as Charles Schwab). Also, for certain stocks investors are charged cash interest on the value of the shares they have borrowed. These cash outflows make short selling a costly endeavor, which necessitates the expected outcome (share price decline) to materialize quicker than is required for a patient long investor to achieve a satisfactory outcome. The following quote, attributed to John Maynard Keynes, is probably the best and shortest warning investors should understand before initiating a leveraged financial position (i.e. short selling, purchasing options, buying securities on margin, etc.) of any kind.
“The market can remain irrational longer than you can remain solvent.”
Given the two points above, short sellers ought to remain nimble and proceed with caution.
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Chas Craig is president of Meliora Capital in Tulsa (www.melcapital.com).
