You can rank investment strategies based on their performance, but where’s the fun in that? If you rank them instead based on their originality and audacity — “The Chutzpah Rankings”, if you will — short selling would dominate the category. It stands out as a strategy uniquely designed to profit from failure and, often, uniquely able to influence the events from which it seeks to profit. It’s not just an investment strategy; it’s a genre of subversive performance art.
One of the acclaimed performers in the category, Muddy Waters CEO Carson Block, released a report last week with headline-grabbing allegations about the safety of St. Jude Medical’s products. The company issued a strongly worded rebuttal. But market forces do not always wait for formal verdicts. St. Jude shares (NYSE: STJ) dropped by about 17% last week. Unlike activist investors who often start their campaigns by inviting management teams to the negotiating table, short sellers prefer to draw blood immediately to achieve the desired outcome. No wonder public companies view short sellers as an existential threat.
The intentions of short sellers are unmistakable. They profit from mispriced and undetected risk. They help re-price risk in part by challenging the assumptions and narratives that sustain current valuations. To be effective, at least in the short run, a short seller’s thesis doesn’t necessarily need to be right. It only needs to be plausible. Given this advantage, public feuds with short sellers can test the leadership and communication skills of targeted companies.
They can’t immunize their shares completely, but public companies can preemptively identify and mitigate the operational and reputational vulnerabilities that short sellers seek to exploit. Ultimately, the only way to reduce the valuation impact of contrarian and speculative chatter is to deliver performance in line with expectations, whether companies achieve this alignment by changing the former, the latter or both.
The alignment of expectations across stakeholder groups with a company’s sustainable performance will not directly rebut any specific short seller’s claims. But it will create an environment in which the targeted company is far less likely to be presumed guilty.