Kevin Stecyk

Acquisition Of CDW Highlights Challenges Of Shorting On Valuation Alone

Josh, your starting point is as good as any. And you're right, many shorts are put on as hedges.

My rationale for the short is missing? No, my rationale was that I believed--wrongly it turns out--that CDWC was overvalued compared to its peers. It's a rather straightforward rationale.

Was CDWC the most overvalued stock in universe? No, most defiantly not. I follow a limited number of stocks that interest me. CDWC was in my universe of technology stocks, and it was one that I thought was susceptible.

Did I have a hedge against it? Not directly, though I do hold other computer and technology related stocks. So in theory, if computer and software technology companies took a thumpin, CDWC would have formed part of a hedge. But that wasn't my rationale. I never performed a correlation analysis, nor did I make any attempt to hedge the same exposure short as I have long.

Did I expect a meaningful positive return? Yes, most definitely. I thought computer related stocks in general were due to correct because of lackluster demand. There's been nothing really new in the PC world for quite some time. Vista was and is not setting the world on fire. While most companies are doing well, there is no desire by most to spend aggressively on technology. In fact, the largest increases in sales by CDWC was not by the private sector, but rather the government sector. In summary, I thought computer related stocks in general would suffer and CDWC even more so.

You've picked one of the most overvalued stocks in general and chose some leaps as a hedge. Generally I don't like that strategy because of the decay of the put option. As time passes, the put option becomes less valuable. So you might even be correct in that the stock is overvalued and gradually drifts down in time, you might still loose on the trade. But I am sure you have thought that through and understand the risks and rewards.

Is picking the most overvalued stock the best strategy? Not in my opinion. One, they can go higher and often do. Two, they can often be momentum darlings and don't trade in relation to valuation. Three, there can be large short positions that result in squeezes, preventing the stock from being properly priced. Four, the analyst community might be in love with the stock and will continue to bull it higher. Have a look at Yahoo Analyst Opinion for your stock: finance.yahoo.com/q/ao.... And on and on. So I don't necessarily think that targeting the highest overvalued company guarantees you a win.

Instead, develop a broad portfolio of stocks, and if you believe that one of the companies you follow--and you can't follow them all--is a strong short candidate, then decide if you want to play the game or not.

The same applies to going long. Do I buy the most undervalued companies? No, I have a broad portfolio with a higher than average concentration in energy and precious metals. That fits with my belief that the commodities bull run has a long ways to go and that oil is not as plentiful as we wish it were. Given that one cannot predict the future price of commodities, I can't say that I have or haven't picked the most undervalued stocks.

I hope that helps Josh.

Thank you for your comment.