Hobson: Learning to Love Short Sellers

THE WEEK: Morningstar columnist Rodney Hobson on the morality of short selling, and a bad week for Provident Financial and Dixons Carphone shares

Rodney Hobson 25 August, 2017 | 12:25PM
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Among the select few tweeters I follow is a guy called Imran Khan, not the cricketer-turned-politician, but in my view far more distinguished. He raised the issue of whether short selling, where you sell shares you don’t own in the hope of buying them back later at a lower price, is immoral.

Short selling isn’t something I would recommend for ordinary investors. Indeed, markets make it as difficult as possible to do since no market wants to see falling prices scare people away. Short selling on the London Stock Exchange is normally carried out by funds that borrow shares for a fee from existing shareholders. The alternative is to buy contracts for difference (CFDs) or trade in futures and options.

I see nothing immoral in taking a position to benefit from falling share prices. Borrowing shares you don’t own is surely no worse morally than borrowing money you don’t have to buy shares. The stockmarket is full of supposed bogeymen: speculators, hedge funds, vulture funds, computer program traders, short sellers.

They are not your enemies. They help to provide the essential liquidity that allows you to buy and sell freely. They are not making fortunes at your expense, for they get it wrong as often as you do. When they drive prices down, they tend to do so excessively, providing long term investors with a great buying opportunity.

So even if you see short sellers as sinners, learn to love them and forgive them their sins. You will get your reward on earth.

Provident Pessimism is Justified

I am an eternal optimist when it comes to stockmarket investing but there are limits, and those who bought into Provident Financial Group (PFG) this week overstepped the mark by some distance.

Provident dropped a remarkable 66% early in the week after the second profit warning in two days, thus beating even Royal Bank of Scotland’s (RBS) one-day disaster eight years ago. The dividend was suspended but the cash saved may not be enough to ward off a cash call.

The main problem at the subprime lender, as we discovered with the first warning, is that the shift from part-time, self-employed agents to full-time employees has caused massive disruption. That is something that cannot be addressed easily, especially after the mass defection of agents. Yet the shares rallied before that day’s close and optimists went on a buying spree for the next three days.

No doubt some of the recovery was caused by short sellers closing their positions but it was mostly down to bottom fishers, buyers who think they have spotted a buying opportunity at the bottom of the slump.

This is, admittedly, quite some bounce for a dead cat but that is what it is – a dead cat bounce. The higher price represents an opportunity to cut losses and get out. There is a time for pessimism, and this is one of the clearest cases you are ever likely to come across.

Mobiles Still in Favour

To prove I am an optimist, I am sticking with my Dixons Carphone (DC.) shares despite this week’s profit warning. The bad news drove the shares down so sharply that I feel it is all fully reflected in the price.

Mind you, I thought that when I took the unfortunate decision to buy in after a previous share price fall and no doubt those more savvy than I am in technology, particularly in mobile phones, saw it coming. I believe this is a genuine case of people putting off upgrading rather than a collapse of the market. 

The shares have halved over the past 12 months. It will be a long time before they recover that deficit. While I cannot in all honesty encourage others to follow my mistake, there is a better case for optimism at Dixons Carphone than at Provident Financial.

Rodney Hobson is a long-term investor commenting on his own portfolio; his comments are for informational purposes only and should not be construed as investment advice, nor are they the opinions of Morningstar.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Rodney Hobson

Rodney Hobson  is a columnist for Morningstar.co.uk and author of several investing books, including The Dividend Investor and How to Build a Share Portfolio.