Tears on Wall Street joyful for short-sellers


There's a misfit at every parade. Cheerleaders kick and cymbals clash -- and a skulking figure in the shadows prays for rain.

In the stock market, these ghouls are investors called short-sellers, contrary types who lie awake nights hoping stock prices will go down.

These days short-sellers are happily predicting apocalypse now. The prices of many stocks, they say, have reached highs that cannot be justified according to historic gauges of market performance, such as price-to-earnings ratios. And they say market values have been artificially inflated by a flood of money into mutual funds, from investors unhappy about low-yielding certificates of deposit, savings accounts and bonds.

"The market is so overbought. It's overvalued by just about any standard we can conjure up," said Michael Long, general partner of Rockbridge Partners, a Charlotte, N.C., firm that pools money for short-selling ventures. "The short seller should get a tremendous benefit when the buying surge in mutual funds ends."

Basically, short-sellers make money the same way ordinary stock investors do, by buying low and selling high. The difference is that short sellers do things backward so that they can profit when a stock price goes down. They sell high, then buy low.

Say you had been studying the American Widget Co. and concluded that its current per-share price of $100 was too high for a stock that usually cost $80. You figure the price will fall to its normal level. Lots of things can make a stock go higher than it ought -- speculation that a company is a takeover target, for instance, or rumors that it's about to announce a new super-widget.

To sell short, you would get your broker to find someone to lend you 100 shares of AWC stock. Then you would sell the shares to someone else for the going price of $100 each. Then you would sit back and hope for the price to drop. (Selling short means you sold shares you didn't own.)

If you were right, the stock price would drop to, say, $80 a share. Then you'd buy 100 shares at that price and give them to the person who had lent you the 100 shares earlier. You'd make $20 a share.

Of course, there's a risk that AWC prices go up rather than down. Then you'd have to replace the borrowed shares with ones that cost more than you made when you sold the borrowed ones. If the price rose to $120, you'd lose $20 a share.

But because stock prices have moved steadily up for two years, short-sellers see lots of opportunities around today.

As with all investment predictions it's hard to separate the wishful thinking from the mathematical probability. Record stock prices have given short-sellers a rough spell and made them like medicine makers longing for an epidemic.

William D. Lyons, editor of Short On Value, a $240-a-year newsletter that touts stocks he thinks will fall, argues that some of the best short-selling prospects are stocks that are Wall Street's current darlings.

He recently told subscribers to look at computer software stocks such as Borland International, computer networking and hardware companies such as Oracle Systems, or "concept restaurants" such as Lone Star Steakhouse.

"Their attraction for investors is that one or more of their products are selling like hot cakes," he said. "The problem is, none of these companies has a lock on the particular technology they're exploiting."

Among individuals, short-selling is done primarily by the more sophisticated investor, Mr. Lyons says. That's because many people don't want to gamble money on a process they find confusing, he says. And short-selling, although it involves the same stock analysis that regular investing does, has long had a tawdry image, like arms peddling.

Mr. Long says there is a small, secretive fraternity of professional true" short sellers that accounts for about only about 5 percent of the total short interest at any one time. Most are limited partnerships that pool money for short-selling picks made by a general partner. Mr. Long tracks their performance in his Rockbridge Index.

In the nine years ended Dec. 31, the index shows average annual earnings for the short-selling partnerships of 16 percent, slightly better than the 15.4 percent average annual increase in the Standard and Poor's index of 500 leading stocks, Mr. Long says.

Short-sellers had a stunning year in 1987, the year of the infamous 509-point October crash in the Dow Jones industrial average. They earned more than 39 percent in the fourth quarter alone and nearly 50 percent for the year, according to the Rockbridge Index.

Last year started well for them as the market languished through the first three quarters, then turned bad when stocks took off in the fourth quarter, giving short sellers losses of about 5 percent. For the first quarter of this year, short-sellers are up 3 percent, Mr. Long says.

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