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Short Your Way To Greater Wealth

moneyFirst a very quick apology about the misleading title to this week’s article. If you know anything about me, you will also know that I don’t believe in trying to make a quick buck by selling shares that I don’t own. In other words, I don’t short shares.

Instead, I am strictly long-term buy-to-hold, which means that I believe in looking for shares that can reward me for the long haul.

So, this week’s article is more about appreciating the underlying value of assets, or more specifically understanding the intrinsic value of shares that you might own or might want to buy.

For those who don’t know, short sellers are traders who believe that an asset might be overvalued. So they might borrow the asset from an existing owner and sell it at the current market price in the hope that they can buy it back at a lower price before they have to return the shares to the lender.

If they are right, short sellers could profit from the higher selling price and the subsequent lower buying price. Yes, short sellers like to do things back-to-front – they sell before they buy.

However, it is quite possible that they could be wrong. Nevertheless, they will still need to buy back the shares but this time at a higher price. In other words, they would lose money on their dealings.

Short sellers, I believe, are much misunderstood. Some people might label shorters or short sellers as anti-capitalists. After all, aren’t asset prices supposed to rise indefinitely?

Others say that short-sellers are unpatriotic, especially if they choose to target a country’s currency or a country’s benchmark index because they might think they are overvalued.

Here in Singapore, a couple of quoted companies have had to weather frenetic trading activities that were initiated by shorters. Last year, Muddy Waters claimed that shares in Olam International were overvalued. Consequently, they shorted the shares. More recently, Galaucus Research claimed that shares in China Minzhong were almost worthless.

I am not going to revisit the whys and wherefores behind the views of Muddy Waters and Galaucus Research, suffice to say that both companies believed that shares in the two Singapore-listed companies were not worth as much as the market believed.

Thing is, they are just as entitled to their opinion as you and I are entitled to our views. That is how stock markets work.

As a result of their views, shares in both companies fell appreciably. So, if you owned shares in either company your investments could have been adversely affected.

However, it is important to appreciate that stock markets can be as much about opinions as they are about fundamentals. If a sufficient number of people believe that a stock is overvalued, then chances are the shares could fall regardless of what you and I might feel about the valuation.

That said, it is equally important that you know enough about the companies you invest in to form an intelligent opinion about what the businesses might be worth. You can only know whether the market is right if you have some idea about the intrinsic value of the business.

Charlie Munger said this about buying shares: “You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced.

So, whenever you hear about short sellers in the market, don’t take it personally. In fact, they might even be doing you a massive favour by giving you an opportunity to buy more of what you like at a cheaper price.

This article first appeared in SIAS e-Newsletter.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.