Short-Selling with the O'Neil Disciples. Morales Gil

After all, a basic reality of the stock market is that a young, new, dynamic company with game-changing technology and a cutting-edge approach can often sell at 100 times forward estimates or more at the very point where it begins a huge upside price run. This has been seen time and time again with stocks like eBay (EBAY) and Amazon.com (AMZN) in 1998, Salesforce.com (CRM) from 2009–2010, or even Taser International (TASR) in 2003 when it had no earnings to speak of and hence an “infinite” P/E yet still was at the cusp of a nearly twenty-seven-fold price move over the next nine months! Such was the case with Tesla Motors in 2013. As we wrote in an article for Forbes.com in early June 2013, “What the GM example tells us is that maybe there will be more to this price move in TSLA than currently meets the eye, and investors should remain open to whatever the stock's future price/volume action tells us and not rely on simple-minded valuation analysis that can often cause investors to miss huge stock market opportunities.”

      One reader commented in the article's blog section (remember that TSLA stock was around $90 at the time), “What about us who are short above $100? How dare you compare TSLA to GM in 1915!!! Now I know the longs are like cult members.” This sort of comment is typical of valuation short-sellers who, as a result of their graduate degrees from the University of “I-Am-Smarter-Than-the-Market,” believe they possess superior abilities and knowledge that they express by denigrating those who buy and profit from strongly trending stocks as “cult members.”

      The mind-set of short-sellers like these is fraught with emotion, and at times it appears that their investment methodology in such a situation is born more of indignation than of any intelligent assessment of the trend and the stock's potential. Tesla Motors (TSLA) eventually moved higher than $290 a share as of the time of this writing, and so our answer to the individual who commented “What about us who are short above $100?” is that we hope they were smart enough to cover their positions once the stock rallied well past the $100 price level. In our experience, however, such individuals simply become even more indignant and continue to short the stock on the way up as they go bust.

      When you argue against stocks like Apple, Netflix, Tesla, or 3-D Systems, you are arguing against the virtuous system of entrepreneurial capitalism that embraces the freedom, nobility, humanity, and shining promise of new ideas, new ways of thinking, positive change, and new products and services that enable people of all socioeconomic stages to improve their productivity, their leisure enjoyment, and ultimately their standard of living, and that is, well, downright un-American! Thus one facet of the dark side of short-selling is revealed, but in fact we see it more as the dumb side of short-selling by those who consider themselves as graduates of the University of “I-Am-Smarter-Than-the-Market.”

      In our view, short-selling is nothing more than a method of investing and trading that recognizes the life-cycle paradigm arising from an economic system that thrives on creative destruction. A major component of that creative destruction is the process of cleaning out prior excesses and forcing the redeployment of capital to more productive areas of the economy. The quicker that process is able to cycle through the system, the better. Stocks, like people, have life spans. Unlike people, however, they can have more than one life span, providing opportunities on both the long and short sides depending on which side of the creation/destruction cycle they are in. Great companies like Apple can experience periods of tremendous growth that fuel a higher stock price, followed by periods of contraction as they become obsolescent and lose their competitive edge. During such a period, the price of the company's stock shares declines as it should. But great companies like Apple also adapt and respond by coming up with new ideas and new products to regain that edge and generate a new cycle of tremendous sales and earnings growth, which in turn fuels a higher stock price once again. In such a manner, a strong, adaptive, and innovative company can be born and reborn many times.

      Investing and trading is about making money by profiting on the price movement of stocks and other securities. Short-selling is simply one component of smart investment and money management. Preserving gains is crucial in optimizing the performance of one's investments over the long term, and short-selling serves as a way to either profit outright or to help offset declines in other stocks that make up the positions in a portfolio with more of an intermediate- to long-term investment horizon during a bear market. The study and practice of short-selling not only provides investors with a useful arrow to keep in their quiver of investment skills, but it also aids in developing one's skill and understanding with respect to when to sell long positions in leading stocks when they have finally reached the end of their upside life cycle.