Gregory J. Blotnick is a senior equity research analyst. He began his hedge fund career in 2009, and currently covers the Consumer sector for a private investment firm in New York City. The firm operates with an event-driven mandate and has the ability to invest all throughout the capital structure, both long and short. Follow Gregory on Twitter at @gregoryblotnick for his latest thoughts on equity and credit opportunities within the Consumer space.
High-Conviction Short Sales: Empathy for the Bull
By Gregory Blotnick, CFA – 10/25/2016 for CFA Institute
Short sellers face what may be the most treacherous backdrop in market history.
Dovish Fed policy has not only boosted equity multiples but led to cheap credit and a boom in M&A. Inefficiencies on the short side are quickly ironed out by thousands of long/short funds desperately trying to justify their 2 & 20. Prime brokers have introduced negative rebates on borrowed securities as banks search for new sources of revenue.
In some cases, a short seller can pay 100%+ in annualized borrow fees just to be exposed to unlimited upside risk . So—why bother?
As seen frequently in research on behavioral finance and counterparty risk, successful short selling requires more than just strong conviction—it demands psychological resilience and a deep understanding of who is on the other end of your trade.
David Einhorn put it simply:
“Selling short individual names offers two ways to win—either the market declines or the company-specific analysis proves correct.”
While broad market declines are nearly impossible to time, focusing on the company-specific thesis gives you a fighting chance.
Empathy: The Edge of a Short Seller
The best short sellers share one common personality trait: empathy —the ability to put themselves in the bull’s shoes. Charlie Munger captured this perfectly:
“I never allow myself to have an opinion on anything that I don't know the other side's argument better than they do.”
Before entering any short position, I always make sure I can answer these three questions cold—a framework I’ve explored further in prior research pieces on empathy.
1. What Are the Bulls Playing For?
You only win as a short seller when the bull thesis breaks —and to know what breaks it, you need to understand it better than the bulls themselves.
This is where the informational asymmetry in short selling becomes your advantage. Most stocks are well-covered by the sell side, and consensus research often reveals lazy assumptions.
A quick method to expose embedded expectations is to reverse-engineer a DCF model —a tactic I regularly use and explain in more depth both in this SSRN piece and on my site .
Key things to watch for:
-
Overly aggressive revenue assumptions
-
Hardcoded margins without operational rationale
-
Missed cyclicality or cost structure nuances
Revisions to these estimates typically drive price action, and consensus forecasts are almost always too optimistic .
2. What Valuation Metric Matters?
Different sectors focus on different metrics. You must understand which one is most salient to the bull case.
Shorting a biotech because of a high price/book, or a software firm for negative trailing earnings, is a fool’s errand. Bulls don’t care—and the market won’t either.
For example, over the years that I've covered not just Consumer, but lateral names in industrial and technology sectors, I've often noted that some management teams condition investors to focus on specific metrics. Airlines and cruise lines train their bulls to look at EPS growth , while Amazon built its following on free cash flow per share .
Short sellers who ignored this dynamic lost money for years betting against AMZN’s high P/E.
3. Does the Time Horizon Match?
Time horizon mismatch is the enemy of many short theses.
Take energy stocks: some trade at triple-digit forward P/Es , yet attract buyers. Why? Because these bulls are looking 3–5 years out to mid-cycle earnings .
This makes it hard to find near-term catalysts and easier to misjudge timing—a critical risk I wrote about in a recent macro and market analysis post .
Cyclicals typically require multiple earnings misses to see downside momentum. This differs from terminal shorts , where you're betting on structural failure (e.g., fraud, bankruptcy, obsolescence).
Even harder are the "mañana stocks" —companies with grand visions years in the future. These are often led by cultish CEOs with a loyal investor base. Remaining short through multiple years of misses, waiting for vindication, is rarely worth it.
Final Word
In a market distorted by excess liquidity, passive flows, and Fed accommodation, short selling is as much about psychology as it is about numbers. But the edge lies in empathy —if you understand your counterparty better than they understand themselves, you can identify where their logic breaks down.
As I've often emphasized in older posts on investor psychology, the most successful shorts tend to come from a place of understanding, not just from a place of conviction.
Focus on high-conviction situations where you can cultivate empathy for the bull—lest your counterparty ends up cultivating sympathy for the bear.
---
Good luck trading,