One of the greatest challenges for investors interested in short selling is unearthing potential ideas from the endless stocks on the market. However, in a webinar, Steamboat Capital shared a number of red flags to look for alongside three new short ideas.
Parsa Kiai of Steamboat Capital also explained why he thinks short selling is an important part of a long/ short strategy — despite the challenges it represents.
Before founding Steamboat Capital in 2012, Kiai helped launch Sonterra Capital in 2008 and was an energy sector analyst at Perry Capital. He started his career at Goldman Sachs’ investment banking division in 2003. Since inception, Steamboat's longs have nearly doubled the S&P 500, and their shorts have significantly outperformed Goldman Sach's "Most Shorted Index" (more on their impressive returns below).
Challenges with short selling
It’s no secret that short selling is very difficult, and Kiai said it’s always been difficult. He also said that it’s continually getting more challenging, partially due to the inherent characteristics of short selling.
The practice is extremely risky because gains can be capped at 100% if the stock goes to zero, but losses can be unlimited because stocks can soar much more than 100%. According to Kiai, the last 15 years have seen short selling become increasingly challenging, leading to a very difficult period following the COVID-19 pandemic in late 2020 and early 2021.
Also see: Steamboat Capital Shares Thesis for CompoSecure, Shares Why Alphabet May Be Undervalued [Exclusive]
Why short selling has been so difficult
He cited several reasons for this. Going back to the Great Financial Crisis, interest rates were exceptionally low for 15 years, reducing a key source of income in terms of the short rebate that short sellers receive. Low rates also slash the cost of capital for most businesses, also encouraging some level of speculation in some of the riskier and challenging business models.
The result was enormous market returns, making the period between 2009 or 2010 until 2021 one of the most challenging periods for short sellers in history, according to Kiai. He also noted that some of the newer casino-like aspects of the stock market today make things even more difficult, like trading apps like Robinhood that gamify investing and products like zero-day expiration options and triple-levered single-stock exchange-traded funds.
“For that reason, we've seen a lot less competition among long/ short investors in active short selling,” Kiai added. “Many short sellers have abandoned the craft. Many people perceive it to be not worth the time and effort, and… this is one area of opportunity in that there's less competition in short selling today. Now, despite all of the challenges that we've discussed, we will make the argument that short selling still is a valuable activity in a long/ short portfolio for several reasons.”
Benefits of short selling
Generally, the equity markets go up over time, as measured by key stock market indexes like the S&P 500. Kiai admitted that those indexes are very difficult to compete with, but considering their composition, most of the individual stocks don’t perform as well as the index. In fact, he said lots of them actually fall.
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