Josh Stern

Acquisition Of CDW Highlights Challenges Of Shorting On Valuation Alone

You should take off 12% for CDWC numbers before the buyout. Also, I don't understand the point of comparing it only to NSIT unless you are actually doing a paired trade, and here is another important number: Operating margin - NSIT 2.52%, CDWC 6.35%. That's a world of difference in either mail order or retailing.

I'm not saying CDWC was a good buyout value; but IMO it wasn't a good example to make a general point about shorting based on valuation.

Acquisition Of CDW Highlights Challenges Of Shorting On Valuation Alone

I understand from the clarification above that you mainly picked CDWC to short because you were negative on the computer industry and felt CDWC to be one of the most overvalued stocks there. Clearly that is a lot different than shorting based on valuation per se, though I'd argued that CDWC doesn't stand out as overvalued (forward P/E less than 20, ROA of 15%, trading at less than 1x sales is not super high valuation compared to, say, the disk drive manufacturers that also sell a commodity).

Re: LEAPS vs. Short - obviously depends on the goal and the option pricing and other market conditions. For something like this where the goal is to hedge and "out of the money" doesn't mean much since it could go down 75% and still be overvalued, I liked LEAPS better.

Analysts - I pay attention to analyst earnings estimates, but regard their buy/sell ratings as a mildly contrarian indicator - i.e. prefer to be long something less loved and short something more loved in terms of buy/sell ratings, since the only future upgrades or downgrades matter in terms of affecting the price.

Acquisition Of CDW Highlights Challenges Of Shorting On Valuation Alone

IMO, a good starting place for a discussion of a short position is a thesis about the expected return from the position and why one believes in that thesis. Since a high percentage of shorts are put on as hedges (either for the trader or for someone else), one can't assume that the trader's expected return for holding the position L length of time is better than a money market return over that period (or that it is even positive). So I am saying that your rational for shorting CDWC was missing from your article. Did you expect a meaningfully positive return from your short or was it just intended as a hedge for other positions in the computer hardware industry? Surely valuation per se wasn't the main basis for the trade because you didn't pick one of the most overvalued stocks. My example is that, by contrast, I've attempted to pick one of the most overvalued stocks but still regard my trade as a hedge rather than something with positive expected value.

Acquisition Of CDW Highlights Challenges Of Shorting On Valuation Alone

The concept "Don't short without a catalyst" is repeated so commonly that it is a cliche. But I honestly don't know why someone who was shorting based on valuation would focus on CDWC when there are so many more absurd valuations everywhere one looks. As an example, consider CCI - it is absurdly overvalued (price to sales of 11.5X and losing money), overleveraged, has no economic moat, decling GAAP and operating income, yet it continues to rise like a moonshot. I've got LEAP puts on it but only think of them as portfolio insurance against a market meltdown, not something I actually expect to make money on.