najdorf

Doug Kass's Killer Shorts - Barron's

About a year later, I'd say Kass's calls look pretty far off the mark. He seems like the kind of guy who's more interested in being contrarian and looking smart than making the maximum amount of money. All of his shorts were atypical calls and few are down more than the SPY (down ~35% since his article) while many have outperformed the SPY significantly.

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.

Where Have All the Buybacks Gone?

There's really no reason to conflate the issues of excessive stock option issuance and stock buybacks (football frank, others). Let's imagine what would happen to a company that issued a ton of options, paid big dividends, and didn't buy back any shares. For a while this company would look great to the high-yield crowd. Then they'd hit a point where all the issuance diluted the free cash flow to the point where it was difficult to continue to pay the dividend and continue to invest in the business. Because most people never learn from the past, they'd keep paying the dividend, a few smart investors would head for the exits, and the share price would start to erode. Then the high-yield crowd would back up the truck for the even higher yield. Eventually you hit a crisis where they really can't pay the dividend any more, cut it radically, and watch the share price crash. All without the dreaded buybacks...

You should only hate options if your management is moronic and corrupt, and you shouldn't invest in companies for which you believe the management to be moronic and corrupt. Paying a great manager in long-term, slow-vesting options at the current market price with a holding requirement is just like paying him in cash, except you motivate him or her even more to make the company perform. If your manager isn't worth it, advocate your point of view to your board. If your board is cutting corrupt deals or looking the other way while management cashs out millions in options while running the business into the ground, fire them. If you can't make action happen, sell the stock to a greater fool and look for a decent investment instead.

The problem is not the buybacks; it's the dilution from overcompensation of poor executives. Buybacks are fantastic if the purpose is to increase the amount of FCF available to continuing shareholders, which can support either further profitable business expansion for a more concentrated group or greater dividends. However, in order for the buyback to work the shares of the company have to be cheaper than those of other companies and cheaper than the immediate direct capital investment options.

For instance, imagine a great business that trades for 5x FCF - unless you can find an expansion plan that yields greater than 20% immediate safe returns, why wouldn't you buy back some shares with the available cash? Why would you pay a dividend to shareholders so they have to pay tax and then go through the hassle of finding a new investment or paying a commission on more shares of something they already own?

Now, there may not be many companies that actually fit the criteria for buybacks - many of the best companies are regularly over-priced in the market and would do better with internal expansion or dividends to income-oriented shareholders. But there's no sound reason to philosophically object to buybacks of all kinds.