Doug Kass's Killer Shorts - Barron's 18 comments
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Barron's interviews legendary short seller, hedge fund manager Douglas A. Kass of Seabreeze Partners Management. Seabreeze Partners Short fund is up 16.5% YTD vs. a 5.6% loss for the S&P 500. Over the past 3+ years, Kass has posted a 40.7% gain.
Kass's general rules for successful short selling:
- No security exceeds 2.5% of total assets and no sector exceeds 20%.
Avoid highly shorted stocks -- determined by a high short-interest-to-float ratio, and by high short-interest-to-daily-volume ratio -- which are easily squeezed.- Avoid leverage.
- Short large-caps (avg. market cap of $10B).
- Do your research: Short companies, not ETFs.
Shorts he likes:
- Consumer stocks. Job growth is declining, as are incomes, while inflation rises -- yet consumers are more levered than ever before. Specifically: Colgate-Palmolive (CL), Kellogg (K) and General Mills (GIS), which will suffer as consumers trade down to generic products.
- Berkshire Hathaway (BRK.A) -- Buffett's outperformance is narrowing as smart/aggressive hedge fund managers crowd out the marketplace. Recently, he lost $1.6B on derivative bets, despite previously eschewing derivatives. Berkshire is heavily exposed to financials (WFC, BAC, AXP). Insurance "salad days" are over.
- Dental stocks. Namely Danaher (DHR), Henry Schein (HSIC) and Patterson (PDCO). Elective dental procedures are declining, and dentists are cutting back.
- Fastenal (FAST) -- sales growth will be difficult to sustain and a profit miss is likely.
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Unimpressed by Kass's arguments, Barron's Alan Abelson thinks Berkshire is cheap at current levels.
Bill Luby notes sustained weakness in the consumer discretionary sector.
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This article has 18 comments:
Thx jegan ;-)
What generic toothpaste is there to buy? C'mon, a $3 tube of toothpaste, that lasts a couple of months, is where people will be cutting back? That's silly.
And, 70%++ of their sales are non-U.S.....so, what is he thinking?
CL is one of the best stocks with the most durable, wide moats available. Better than COKE, anyday, since the product is so cheap per use, and is beneficial, and has an entrenched global market share of 40% and is growing like a weed in emerging countries where people are brushing more and better.
Doug, pick on something else, this is a stupid short idea.
Yes, people who feel poorer will thrift just about anything - even toothpaste and TP; opting to buy generic over name brand. And they will do so even when both are within just a few pennies of each other.
I've known people who would drive 30 miles out of their way to save a couple of pennies per gallon of gasoline despite the fact that they burn $3 to do it. The average consumer is not always the epitome of homo economicus rationality.
Caveat commodator
I will take Doug Kass over Alan Abelson 7 days/week, 52/weeks a year.
Quick note re: Fastenal. Shorting Fastenal is a tough way to make a living. I'd much rather short HD, LOW or even homebuilder stocks. If FAST has a bad day, HD and LOW will likely suffer in sympathy. But, wait, these stocks are probably shorted by everyone and their brother, so Mr. Kass is worried about losing money on a short covering rally.
One correction that I'd like to suggest...Berkshire did not lose 1.6 bilion on derivatives contracts. It sold equity puts on major US indices for 20 year periods and got premiums upfront. These contracts are essentially like selling an insurance policy to someone. Buffet gets to invest the float for 20 years and may not even have to pay anything (and will likely make 3x-4x by investing the float). The The 1.6 billion "loss" is just the fair value accounting at work and will likely fluctuate up and down every now and then. Outside of the up-front premium, no money changes
hands till contracts are settled.
Pasting from Berkshire's 10-Q:
"The estimated fair value of the equity index put option contracts at March 31, 2008 was approximately $6.2 billion, an increase of $1.6 billion since December 31, 2007. The increase was primarily due to fair value losses of $1.2 billion as well as $383 million in premiums from new contracts entered into in 2008. There were no cash payments made under the equity index put option contracts.
The aforementioned contracts are not traded on an exchange. The contracts were entered into with the expectation that amounts ultimately paid to counterparties for actual credit defaults or declines in equity index values (measured at the expiration date of the contract) will be less than the premiums received. The contracts generally may not be terminated or fully settled before the expiration dates (up to 20 years in the future with respect to equity index put option contracts) and therefore the ultimate amount of cash basis gains or losses will not be known for years.
Berkshire does not actively trade or exchange these contracts, but rather intends to hold such contracts until expiration. Nevertheless, current accounting standards require derivative contracts to be carried at estimated fair value with the periodic changes in estimated fair value included in earnings. Fair value is estimated based on models that incorporate changes in applicable underlying credit standings, equity index values, interest rates, foreign currency exchange rates, risk and other factors. The fair values on any given reporting date and the resulting gains and losses reflected in earnings will likely be volatile, reflecting the volatility of equity and credit markets. Management does not view the periodic gains or losses from the changes in fair value as meaningful given the long term nature of the contracts and the volatile nature of equity and credit markets over short periods of time."
I don't understand why Mr. Kass didn't have a problem when had an investment style drift before (that led to billions of dollars in wealth creation), but now raises an issue. Me thinks Mr. Kass doth protest too much.
How is his new style of investing any different from hundreds of other money managers, who like to buy good businesses at fair valuations? Most of his stalwart bluechip picks of gone mostly sideways for years, so, how has he added all this value?
Sure, his Berkshire businesses have performed well, run, of course, by other people. So, he's a good hands-off delegator. But as far as the investing in common stocks goes, either him or Lou Simpson have not exactly outperformed much of the pack in recent decades.
Buffett says it's because the numbers are now too big.
Well, may be, but, maybe he should figure out a way to split things into smaller pieces that could outperform.
I mean, since when did conglomorations ever really prove to be a great vehicle for producing outstanding results?
He's nothing but another Henry Singleton in many respects.
Dexter Shoes? Wells Fargo (King of Home equity 2nd mortgages and other regretful consumer loans in California and other the other former bubble states?) Geez, how uninspired is that?
Buffett's investment style has drifted and will continue to drift. So long as Buffett believes he can create value, he will retain the funds at Berkshire -- otherwise, he will dividend out the cash so shareholders themselves.
The most important point that paulmars misses is that Buffett continues to create vast billions in value OVER TIME despite the continues changes in the market place and increasing competition (especially from the so called smart investors like hedge funds). Berkshire CONTINUES to be the go-to place for financial deals that needs to get done. Buffett has paraphrased Grahm's wisdom: "Though the stock market functions as a voting machine in the short run, it acts as a weighing machine in the long run." Simply stated, Buffett's long term track record has never been equaled. Due to Berkshire's size, their performance will not match previous results, but it will still be better off than having the individual shareholders receive dividends and invest for themselves, respectively.
Cheers.
PS paulmars, do let us know when you made $62 billion from your investments.
If one had a short bias as of last May, one could have done much better shorting just about any financial other than BRK/WFC/AXP - look at BAC, C, WM, AIG, FNM, FRE, WB, etc over the year. I know all about hindsight, but if your thesis is that financials are s**t why would you short the strongest and ignore much weaker companies still trading at decent prices? Why not short people who are in the same business as BRK with more leverage and less competence?
Likewise in consumerland: if the consumer is weak, why would you short toothpaste and cereal instead of cars and luxury goods? You could have done much better shorting GM or most clothing retailers. Auto sales can fall a lot faster than cereal sales and GM has been obviously over-levered and unprofitable for years, yet the shares were over 20 a year ago (I was surprised too).
He also totally missed the fact that commodities were in a bubble last spring/summer. Short CHK, FCX, etc.
Overall it seems that Kass overlooked the fact that the best shorts are companies with broken business models, over-exuberant speculative action, or excessive leverage - you want some chance that the stock explodes completely if you're going to take the risk of shorting. While you might make 10-20% shorting companies that will experience moderate but survivable business declines in the worst economic conditions in decades, this is a pretty terrible short list given the shorts that were available last year. It would seriously take you a while to find worse shorts than these - even MCD, WMT, and most utilities are down over 1 year. I didn't make any short calls last year, but I'd like to think that even I would have stumbled across one true disaster in a list of 10 shorts a year ago. None of his picks have even come close to blowing up.
I'm not saying it worked this time, but in general he seems to be looking for a "variant" view (he often uses that term)... in this case, where there's minimal chance of a squeeze. Part of it is risk management....