There is three ways to make money on the markets buy a stock to make a capital gain as the stock increases in price; buy a stock for its dividends and hold the stock and over time the price will increase as long as it continue to increase its dividend and make a capital gain by selling the stock short or expecting the price to fall and buying it at a lower price. The third one for 95% of investors should be avoided unless you follow commodity markets and link them to individual stocks. The reason the overwhelming majority should avoid is the leverage needed to do it and if you are wrong it will cost you. If you really believe a stock is going short look at the options market to buy puts. For dividend stock buyers, short selling is on the list because once the stock is paying no dividend (it has to conserve its cash)  its is time to seek alternatives.

Having said the above, there are lessons to learn from short sellers – how they look to find the stocks and what they are looking for. If you see anything like it in your mature company, it is time to find alternatives and exit quickly. Fabrice Taylor wrote a column called why I’m not buying this short selling argument concerning a company called Badger Daylighting. The company is in the service industry to the oil and gas drilling. The price of oil fell and a slowdown in drilling resulted, how good is the company’s future?

The first piece is a newspaper article – if the article is in the Wall Street Journal, Barron’s, a trade industry or the financial paper of a country the general public will read it. If you are a short seller, you need an article in the newspaper to sow doubt that maybe all is not right with the company. In this case, an article in Barron’s questioned the company’s valuation and accounting.

In terms of valuation or the price earnings (P/E) ratio, it is used as a comparison to the broad market and other companies doing similar things. One should not use valuation as a good reason to short a company. There are often reasons why valuation is higher or lower – in the case of Badger – it beat its expectations on the quarter and increased its dividend, two good reasons to having a higher valuation.

Accounting is what everyone focuses on in particular how is revenue collected and how much many days are bills outstanding? what is the write off policy? Naturally at every company, no one wants to write off debts but it is a normal course of doing business. One method of comparison is to see what the competition is doing? In this case when oil prices fell and companies cut back on their programs all companies must have felt the pain both in terms of growth and maintaining their position. In turns out Badger as the industry leader had a more diversified base than the competition and may not have to write off as much as the competition.

Besides voting for Board of Directors, you vote for auditors. Most companies keep the same auditors but if the company moves from one brand name auditor to another brand name to save fees, then it is a little concern. If the move is from a top brand audit firm to local one with a couple of partners who mainly do small business, as a shareholder you have to wonder why? This was a Bernie Madoff red flag.

Costs – if you short stock you will need to borrow the stock, in Badger’s case you also have to pay the dividend. The cost is about 13%, ideally if you short stock you will be sell in a reasonably short period otherwise the cost of holding begins to build up and the greater the price has to fall in order for you to make money. In the case of Badger, about 66% of the shares are owned by institutions which means they have been sold a story for them to hold the stock. Just because they are big, does not make them correct but the reasons why you are shorting the stock has to be even better. In the movie The Big Short it took months before people saw what the shorts saw. In the case of the oil industry and with the new President elect – he would be happy with more drilling.

Linking to dividend paying stocks, there are many theories on how to make money on the market and many will be right for a short period of time. For a longer period of time – buying companies which pay dividends and can continue to increase the payments will push up the P/E Ratio and translate into capital gains. The system has worked but trying to see what others see is always a good idea.

There are more questions than answers, till the next time – to raising questions.