Should you be scared of short sellers?

Shorting is a controversial practice but should shareholders potentially on the receiving end be worried?

Short sellers have been called a lot of names over the years, many of them unfit to print. Being a strange breed, they probably wear these insults as badges of honour.

It is not hard to see why many investors find short sellers repulsive, let alone evil, as some have been called. By betting on a company’s share price falling, shorters often find themselves making money whilst everyone else loses theirs. Profiting from the misery of others? Well, maybe.

The appearance of a short seller — no doubt from some dark alleyway or tunnel — is often enough to spook investors. But should you actually be worried?

Firstly, it’s important to remember that short selling is no different to someone selling you their shares when you place a buy order. It is simply a difference of opinion, a necessary condition in the making of a market.

Secondly, short selling is much more widespread than many realise. In fact, there’s a high probability that every company in your portfolio has at least some shares currently ‘held short’. ASIC produces daily reports outlining how much of a company’s shares are held for short selling purposes and its latest had more than 450 companies, including many of the ASX’s largest companies, as having the highest.

Finally, not all short selling is a bet that a company is going to go broke or suffer a rapid fall in its share price. Nor are short sellers always right. JB Hi-fi (ASX:JBH) has been one of the most shorted companies on the ASX for years. Despite this, the company’s share price has been a standout performer.

At Intelligent Investor we appreciate and closely listen to views different to our own. It’s perhaps the best way to test our investment case. In that sense, shorters shouldn’t scare you.

But the fact remains short sellers have made some brilliant calls and made a lot of money betting on company collapses. Jim Chanos (who we profiled, along with the subject of short selling, in a special report) as well as Australia’s own John Hempton of Bronte Capital are two excellent practitioners of the art.

A common theme is either suspect accounting (Enron), debt-fuelled bubbles and/or unsustainable business models (ABC Learning and Dick Smith). It is in situations such as these, where it pays to sit up, pay attention and investigate.

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