The Art of Short Selling by Kathryn Staley

Hi,

I've been reading a book called The Art of Short Selling by Kathryn Staley. I think she does a wonderful job of explaining how to go about finding and researching short selling. So I thought that over the next few weeks, I'd summarize the various chapters and share it with my readers.

Chapter 1
Just so we are all clear - Short selling is selling a security that the seller does not own but promises to deliver by borrowing it from someone else, in order to profit from the subsequent price drop.

What sorts of companies are short sellers looking for?

1. Companies whose management lie to investors and obscures events that will affect earnings.

2. Companies with over-inflated stock prices

3. External events that have a negative impact on companies

The only way to find these companies is to read extensively (WSJ, Barrons, various trade publications, SEC filings etc), talk to people in the industry.

The process of researching a short sale has 6 steps:

1. Analysis of the company's financials - cash flow statements, breakdown of its balance sheets and the quality of the earnings.

2. Track insider trading activities and management's salaries through their Form 4s, Sch 13D and DEF 14A filings. Importantly, try to understand how the management views its shareholders. Are they shareholder value driven or are they in it for themselves?

3. Check the company's business strategy execution. Does it run its business well? How does the company stack up against its competitors?

4. Follow the stock's trading patterns, short interest, 13D filings by institutional shareholders.

5. Read anything to determine the consensus.

6. Watch the company over time to see what happens, how earnings and price progresses and what changes.

Risks of short selling:

1. The price moves up after the stock is sold, requiring more cash infusions into the account.

2. Or the lender demands the return of the stock. If the broker cannot find another position to loan to the short seller, the customer will be forced to buy it at the current market price. This is called a buy-in. To avoid the risk of buy-ins, some short sellers only short large cap stocks and never discuss positions or talk to reporters.

All in all, short selling is not for the faint of heart or for the inexperienced investor.

Thanks for reading.
Shaun