In light of recent, historically significant market events surrounding retail trading activity in stocks like GameStop, we are here to share our perspectives.Feb 2021
Howland Capital is not involved, and has no intention of taking any action, in any of these activities. Recent market unrest involves individual (“retail”) investors organizing on platforms such as Reddit and trading on platforms like Robinhood to buy shares and speculate in stock options in a coordinated fashion. This activity has resulted in unusual volatility in a number of specific stocks. The common thread among the stocks making headlines is that they are all heavily “shorted” by professional investors. In other words, hedge funds are betting against, or “shorting” these stocks because the fund managers, using fundamental research, have high conviction the stocks will fall in value.
Retail investors have been buying the same stocks, causing their share prices to rise, sending volatility skyrocketing and forcing certain hedge funds to endure massive losses. All of this activity is super-charged by zero-cost trading and buying on margin (the use of leverage). In some instances, it is the widespread use of leverage that creates significant downward pressure on stocks, and subsequently the broader market. Please see below for more information on the mechanics of short selling.
At Howland Capital, as long-term-investors, we generally do not short stocks on behalf of our clients. In fact, we tend to avoid buying stocks that others are selling short to extreme levels, mainly because this type of magnified short selling is usually focused on high-risk companies in precarious situations. Two primary goals of managing our clients’ investments are long-term capital appreciation and maximizing after-tax returns. We favor high quality companies with sustainable, long-term competitive advantages, proven management teams, and track records of earnings and cash flow growth. Such companies are far less likely to attract short selling to extremely high levels.
We recognize the fact that recent market activity surrounding short selling is reverberating through other areas of the market – not to mention garnering the attention of the SEC and other regulators. As always, Howland Capital’s Investment Committee is on the lookout for market dislocations that provide opportunities to buy and sell specific stocks at favorable prices. We stand at all times ready to act to our clients’ advantage. Gambling, as well as battling hedge funds and retail investors, have no place in the strategies we employ at Howland Capital.
The Mechanics of Short Selling and Why it is so Risky
Short selling works like this: an investor borrows a stock from its owner and then sells that borrowed stock with the hope the stock will fall in value. At a later date, the investor who borrowed and sold the stock has to buy the stock back in order to return the borrowed shares to the original owner.
Here is a hypothetical example. Investor A borrows and then sells XYZ stock at $100 per share. XYZ then falls to $80 after announcing disappointing profit results. Investor A then buys XYZ back for $80 and returns it to the owner from which it borrowed the stock, pocketing $20 profit. However, if XYZ rose to $120 instead of falling to $80, Investor A would have lost $20 (sold short at $100, “covered” or repurchased shares at $120).
The most one can lose from owning a stock is 100%. For instance, if the original owner of ABC bought it for $100 and the company goes bankrupt, sending the stock to $0, Investor A would have lost 100% of the money invested. Painful for sure, but downside is known upfront and is limited.
As we have all witnessed recently with GameStop (GME), short selling can be extremely risky. The downside risk to short selling is unlimited. Take the example of GME which sold for as low as $3 less than one year ago. If Investor A shorted (borrowed and sold) GME at $3, but was then forced to “cover” the short (buy it back and return shares to the original owner) at a price of $350 per share, that’s a 11,567% loss! Doing this with one share would be a $347 loss, but doing it with 1,000 shares (a $3,000 short position, seemingly not very big) would result in a $347,000 loss on a $3,000 short position!
We hope this helps brings a bit of clarity to what we are all seeing in a market that has been influenced by an emerging group of investors meaningfully impacting short-term market movies. While this dynamic is certainly wreaking havoc on some investors, it is not what we do, nor ever will, at Howland Capital.
Wishing you all the best,
The Howland Capital Team