How I Generate Short Ideas
Waterloo has extensive experience of investing in short strategies that dates back to 2000. The firm
managed a short-biased hedge fund from 2000-2013 and a fully-invested short fund from 2007-
2010. Waterloo and Logan Capital Management co-managed a long/short hedge fund between
February 2011 and December 2012. In regard to our current sub-advisory role for Logan Capital's Long/Short strategies (which includes a mutual fund and separate account options), Waterloo is
responsible for the management of the short positions and the long/short asset allocation. We apply
the same methodologies used in our prior ventures.
Our short selling investment approach involves a disciplined, methodical search for “flawed” companies with timely catalysts. Such flaws may be evidenced by high inventories or accounts receivable, decelerating sales growth, heavy insider selling or deteriorating technical factors. We then carefully scrutinize the quality of earnings of such companies. We believe that a key to successful short investing involves not only the successful identification of critical “flaws”, but careful consideration of the time horizon that we think is likely to be required for positions to become profitable. By emphasizing catalysts, we seek to avoid potential short situations that would require extensive holding periods and their attendant increased costs and risks.
We usually identify flawed companies through our proprietary initial screening process. This process focuses on companies with slowing sales growth and rising working capital. We begin with a database of 7000 stocks. We weed out companies that trade less than 100,000 shares or have stock prices below $10.00. We also exclude companies in industries where our type of bottom up financial statement analysis is not as effective. For example, we exclude concept stocks, cyclical sectors, and biotechnology. We also weed out companies that have had positive revenue surprises. In our screens, we prioritize companies experiencing negative sales surprises and negative sales revisions as we believe sales shortfalls are generally precede earnings disappointments.The list of candidates includes about 200 stocks. We then perform financial statement analysis with an emphasis on quality of earnings. We attempt to understand the bull position/psychology by analyzing the Street research. This process produces a universe of approximately 50 companies that we are willing to short if the chart pattern sets up and a catalyst is approaching.
Many short sellers have strong opinions that the stock market is egregiously overvalued and they have unshakable conviction in the short positions that they select. This mindset can often create volatility as the market can become even more overvalued and bulls often ignore rotten fundamentals longer than a short seller can stay with a position. We, on the other hand, do not have strong opinions on market direction or valuation, but instead focus on our system and methodology, including a strong appreciation for the necessity of risk controls. We are willing to reduce exposure in companies that we still believe are fundamentally flawed if the alternative would mean greater volatility and/or drawdowns. Short selling, under most circumstances, is never an easy endeavor. One has to be realistic in their expectations and strive not to be emotional, By staying disciplined, we believe the odds for short selling success can be improved.
Our short selling investment approach involves a disciplined, methodical search for “flawed” companies with timely catalysts. Such flaws may be evidenced by high inventories or accounts receivable, decelerating sales growth, heavy insider selling or deteriorating technical factors. We then carefully scrutinize the quality of earnings of such companies. We believe that a key to successful short investing involves not only the successful identification of critical “flaws”, but careful consideration of the time horizon that we think is likely to be required for positions to become profitable. By emphasizing catalysts, we seek to avoid potential short situations that would require extensive holding periods and their attendant increased costs and risks.
We usually identify flawed companies through our proprietary initial screening process. This process focuses on companies with slowing sales growth and rising working capital. We begin with a database of 7000 stocks. We weed out companies that trade less than 100,000 shares or have stock prices below $10.00. We also exclude companies in industries where our type of bottom up financial statement analysis is not as effective. For example, we exclude concept stocks, cyclical sectors, and biotechnology. We also weed out companies that have had positive revenue surprises. In our screens, we prioritize companies experiencing negative sales surprises and negative sales revisions as we believe sales shortfalls are generally precede earnings disappointments.The list of candidates includes about 200 stocks. We then perform financial statement analysis with an emphasis on quality of earnings. We attempt to understand the bull position/psychology by analyzing the Street research. This process produces a universe of approximately 50 companies that we are willing to short if the chart pattern sets up and a catalyst is approaching.
Many short sellers have strong opinions that the stock market is egregiously overvalued and they have unshakable conviction in the short positions that they select. This mindset can often create volatility as the market can become even more overvalued and bulls often ignore rotten fundamentals longer than a short seller can stay with a position. We, on the other hand, do not have strong opinions on market direction or valuation, but instead focus on our system and methodology, including a strong appreciation for the necessity of risk controls. We are willing to reduce exposure in companies that we still believe are fundamentally flawed if the alternative would mean greater volatility and/or drawdowns. Short selling, under most circumstances, is never an easy endeavor. One has to be realistic in their expectations and strive not to be emotional, By staying disciplined, we believe the odds for short selling success can be improved.
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