Montier's Unholy Trinity Screen: Three Important Factors for Short-Selling

Tuesday, Jan 31 2012 by
7
Montiers Unholy Trinity Screen Three Important Factors for ShortSelling

Three years ago, James Montier, renowned economist, analyst and behavioural investing expert (then working in equity research for Societe Generale), issued a note now famous in investing circles that lent support to short selling. At the time, he felt that market conditions were presenting very few bargain value opportunities, while the number of companies falling into his “sell” basket was growing. In response, he defined an “unholy trinity” of factors that could determine a potential short candidate, looking for highly valued story stocks, with deteriorating fundamentals and poor capital discipline. 

Background

As we've discussed, investors that pick stocks on the basis that they are likely to lose value tend to attract ire and suspicion from the wider investment community. Generally speaking, company directors, financial regulators, government officials, analysts and even conventional value investors will have a beef with anyone outwardly questioning or, heaven forbid, taking short positions on a stock. Rooted in the investment psyche there is a perception of something unseemly and negative about potentially making a profit from a share that loses value.

But what if a company looks expensive or makes the wrong decisions or the stock fundamentals are just plain troubling? Can one also make money? And would that be such a bad thing? According to James Montier, it wouldn’t. In his words:

Vilifying short sellers is the equivalent of punishing the detective rather than the criminal.

With that in mind, he came up with the following useful set of screening criteria to identify potential short candidates: 

1) It should be a story stock

First, the stock has to be expensive on a price-to-sales basis. In other words, it needs to have a valuation in excess of 4x revenues. By Montier’s own admission, this particular measure of a company’s value is problematic in ignoring profits but he feels that this criterion hones in on the story stocks - those stocks that have lost all touch with reality. To illustrate the absurdity of using sales as a justification for a high valuation, Montier cites Scott McNealy, the then CEO of Sun Microsystems:

"But two years ago we were selling at 10 times revenues when we were at $64. At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get…

Unlock this article instantly by logging into your account

Don’t have an account? Register for free and we’ll get out your way

Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested.


Do you like this Post?
Yes
No
7 thumbs up
0 thumbs down
Share this post with friends




2 Comments on this Article show/hide all

anahin 1st Feb '12 1 of 2
1

One of the tenets of value investing is that it's reasonably easy to predict what will happen but almost impossible to say when.

So one can hold on indefinitely to a good stock knowing that it will eventually be profitable.

But one can't hold on to a short position indefinitely. That's the only reason short selling is never recommended by Ben Graham.
Not because it's impossible to say when a company is overvalued.

| Link | Share
emptyend 1st Feb '12 2 of 2

One of the tenets of value investing is that it's reasonably easy to predict what will happen but almost impossible to say when.

So one can hold on indefinitely to a good stock knowing that it will eventually be profitable.

But one can't hold on to a short position indefinitely.

Excellent points!

Another reason (which is just as important a reason why I don't sell short), is that long positions are always bounded by zero - whereas losses on short positions can be unlimited. This article gives an excellent illustration of the dangers:

Hedge funds have lost £18bn in two days of trading in Volkswagen (VW) shares that briefly saw the carmaker become the world's most valuable company.

VW shares rose 348% over Monday and Tuesday after it emerged that only about 5% of its shares were available.

It is impossible to guarantee the availability of stock to borrow except over relatively short time periods.

ee

| Link | Share

What's your view on this article? Log In to Comment Now

You can track all @StockoChat comments via Twitter


About Stockopedia Features

Stockopedia Features

Stockopedia Features covers in-depth stories on strategies, companies and themes that are relevant to online investors. Investing is hard work. We don't try to over-simplify complex concepts - we prefer to try to help you navigate the detail.  more »


Stock Picking Tutorial Centre



Let’s get you setup so you get the most out of our service
Done, Let's add some stocks
Brilliant - You've created a folio! Now let's add some stocks to it.

  • Apple (AAPL)

  • Shell (RDSA)

  • Twitter (TWTR)

  • Volkswagon AG (VOK)

  • McDonalds (MCD)

  • Vodafone (VOD)

  • Barratt Homes (BDEV)

  • Microsoft (MSFT)

  • Tesco (TSCO)
Save and show me my analysis
Foliobuilder