Shorting is hard because the stock market generally goes up. But shorting ain’t a bad idea when valuations are stretched and technological disruption is high. In this introduction we share a list of the key technological disruptions creating short opportunities, a list of the impacted industries, and characteristics of a bad stock investment.
We will be sharing a list of stocks that we believe fit this criteria in a week or two. Your suggestions are appreciated.
Technological disruption is being driven by several revolutions...
Mobility as a service (MAAS) is the movement away from car ownership in favor of service options and mass transit. We believe the bounce in car demand during the pandemic was a temporary reaction to the inaccessibility of mass transit. We wrote a piece about the decline in demand for cars which we believe will continue in 2021 in part because of options including Uber, Lyft, Scooters, bikes and car rental service platforms such as Turo.
Autonomous Driving is around the corner because of Tesla. No other competitor is close. When Tesla does receive regulatory approval of fully autonomous driving the cost of taxis and trucks will fall by around 80% overnight. This will not only massively increase the move toward MAAS. It is also likely to kill remaining demand for ICE vehicles and short range railroads and airlines.
Electric Vehicle S-Curve Adoption is forcing every car company in the world to pretend they have a plan to compete with Tesla. Many new EV companies are popping up that don't even have any revenue but are commanding billions in market cap because of investor demand for exposure to this space. Some will survive but many will fail. EVs are much simpler then ICE vehicles...containing only about 10% of the moving parts and requiring only about 30% of the maintenance costs.
Renewable Energy S-Curve Adoption is going to kill off the fossil fuel industry. The reason comes down to the decreasing cost of renewable energies like solar and lithium batteries which are now cheaper in many parts of the world. Renewable energy is getting cheaper at about 15-20% a year while the costs of fossil fuels rise as a result of tougher regulations and a lack of investment.
Additive Manufacturing is the proper term for 3D printing. This new approach to manufacturing is disrupting traditional manufacturing. Disruption from 3D printing happens very rapidly. For example, hearing aides jumped to nearly 100% construction via 3D printing within just a few years. Products that are better tailored to individuals, have many complex parts, and don't need to be produced at large scale are most likely to switch over to 3D printing in coming. years.
Genomics is the mapping, use, and manipulation of our genes. Millions of genomic sequences are already been performed each year for adults that want to learn more about their ancestry, scan for genetic diseases, and assess their risk of gene related health risks. CRISPR technologies allow us to change our genes making the application of genomics hard to image. Traditional healthcare is likely to be disrupted. The second order effects could be disruptive as well such as the impact on how we grow our food.
Digital Payments are displacing cash and credit cards. Companies like Square make it easy to run a business without even having a bank account. Square own Cash App which allows anyone to exchange money and Bitcoin with nothing else other than an email address or phone number. Money is dirty so even after the pandemic is over we expect people to prefer using digital payments. The best part is that these payments are free, unlike credit cards which often charge 3% to businesses and over 20% on outstanding debt.
Work-From-Home is likely to remain a trend long after the pandemic. Many companies learned the hard way that they are spending more on commercial real estate then they were gaining in productivity. We expect the commercial real estate industry to be under pressure for many years to come.
These technologies are likely to disrupt many industries. We are still fleshing out the details but here is the short list...
ICE Vehicle Manufacturers...even those that are now finally hoping on the EV bandwagon.
Car insurance companies
Taxi companies that have no viable path toward autonomy
Railroad companies that compete against trucks
Airlines that would compete against autonomous taxis
Oil and gas companies
Fossil Fuel dependent electricity providers
Brick and Mortar retailers......even those that are now finally hoping on the online bandwagon.
Commercial Real Estate companies
Financials companies dependent on brick-and-mortar and/or credit cards
Health care companies that provide services disrupted by genomics
Manufacturing companies disrupted by 3D printing
Characteristics of a bad stock
Not all companies within these industries make for great shorts. Many investors are aware of these technological disruptions and may already be bidding down the valuations on related stocks. Companies that manage to turn the corner could do very well bouncing off lower valuations.
For these reasons, we only want to short companies with "Negative Skew" ... meaning that the potential upside of low compared to the downside. We wrote an article about "Positive Skew" to help identify good investments. "Bad Stocks" ... are simply the opposite. We believe that the following characteristics help to define a negative skew stock.
1) Positive Sentiment
2) No Moat
3) Downward trend
4) Bad product/service
5) Ripe for disruption
1) Positive Sentiment - The Reopening is creating an unusual environment in which many bad stocks are experiencing a rapid rise in price. Investors on the whole tend to get carried away when this happens...becoming increasingly positive about a stock just because they made money on it recently. We expect this to create some great short opportunities as bad companies get carried up with the good ones because of all the positive sentiment. Ideally, a great short is one in which it would be challenging for investors to become even more bullish on.
2) No Moat - We wrote an article about "Competitive Moats". Those that don't have any of these are likely facing something close to "Perfect Competition". Most firms lack moats. Grocery chains, clothing stores, airlines, convenience stores, refrigerator manufacturers...etc are all highly competitive businesses with low barriers to entry. A special case of negative skew firms include those subject to perfect competition. These include commodity producers such as oil extractors and refiners, transportation services like trucking, car rental, hotels, and farming. When the product you produce is the same as your competitors then you have very little hope of sustained profitability.
3) Downward trend - Many firms subject to perfect competition are able to be profitable for long stretches of time. For example, the hotel chain Marriott has done well since going public in 1993 so long as the economy was strong. That’s why it’s important to wait for a downtrend. No one can hope to understand all the complexity of even a simple business model like a hotel chain...but headwinds that cause a firm to miss earnings projections often have long life cycles. For example, Marriott was struggling for a couple years even before the pandemic as AirBnB took market share. AirBnB isn’t going away. Hotels are simply more competitive than they used to be. We want to short companies that were not looking good even before the pandemic.
4) Bad product/service - Don’t ever short anything that brings you joy. It’s just that simple. If it brings joy it is not a pain point. Traditional auto dealerships are a great example. Buying a car is painful process of haggling over price, losing 30% of its value the moment you buy, paying insurance sucks, parking sucks, taxes on new cars suck, car mechanics screwing you and repair costs suck, trading in your used car for 70% of what you could get selling yourself blows, and selling a car yourself also sucks. The whole process of buying, owning, and selling a car is a bad experience that we go through because we have to...or did until now.
5) Ripe for disruption - Painful experiences like the lifecycle of car ownership are ripe for disruption because they account for a huge part of the typical household budget and are just now starting to become an option instead of a necessity. Tesla took even more market share then we were expecting during the pandemic because they were the only car company that allowed anyone to buy in a few minutes using a phone. Disruptions happen fast and financials don't show it until it's too late. As we wrote about here...algorithms that price stocks based on historical revenue growth and margins have no way of accounting for disruptive technologies. They just extrapolate priced right off a cliff. By targeting industries that are just becoming disrupted you can take advantage of these algos instead of being a victim.
We are building a list of bad stocks to short after our Reopening Trade as run its course. If you want to help then please we recommend reading Ark Invests report on "Bad Ideas". They did a great job talking about some of the these we articulated above. What they did not do is share any actual stocks worth shorting.
Ark Invest Report on Bad Ideas: https://ark-invest.com/badideas/
We will eventually share our short list on this blog, but if you want early access you can get it by emailing us at firstname.lastname@example.org with answers to these four questions...
Which "Bad Ideas" in the Ark Invest report do you agree with the most? Why?
Which "Bad Ideas" do you agree with the least? Why?
What "Bad Idea" do you think might be missing? Why?
What is one "Bad Stock" that you believe is a good short? Why?
Thank you for sharing your thoughts.