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The Pain of Paying: The Psychology of Money

And..another great video from Dan Ariely, James B. Duke Professor of Psychology & Behavioral Economics.

During this session, you will learn:
– why paying with cash for a nice dinner feels worse than paying with a credit card
– how AOL underestimated internet usage with a change in pricing structure
– how to get maximum enjoyment from your vacation

If you like this, don’t forget to sign up for Ariely’s course: A Beginner’s Guide to Irrational Behavior at Coursera starting March 25. I did.

Here are the key take aways:

Ariely IAriely IIAriely IIIAriely IVAriely V

Kyle Bass’ Analysis of the Macro Environment

I appreciate his fact-based thinking. Take the time to listen to his analysis, it’s worth it.

Some quotes:

  • Debt has grown with CAGR of 11% over the last 10 yrs.
  • We sit today at the largest accumulation of peacetime debt in world history
  • You know how this ends right?…..This ends through war…I don’t know between who and who…
  • War is just is just economic intrepid playing out to its logical conclusion….
  • Southern Europe and Japan is going to restructure
  • Social fabric of the world is going to be stretched or thorn within 2-3 yrs
  • But there is a general reluctance to admit we’ll have to go through this

On Germany…

  • The country is much riskier than perceived…
  • Germany defaulted twice last century
  • They have on-balance sheet sovereign debt of 82% of GDP
  • Their banks are 340% of GDP…


  • There’s no chance Japan can ever repay its debt
  • Xenofobe society
  • Social security funding debt is the cancer on their income statement
  • more adult diapers sold than kids diapers
  • In the next 2-3 yrs they cannot hang on
  • the 10th finance minister in the last 6 yrs
  • from the Japanese budget plan: the pensions will be financed through future radical reform (!!)
  • they don’t know what to do and don’t know where to go…
  • retail ownership decreases from 5% to 3.5% because population is dissaving..
  • this it how it all ends

Ackman vs. Herbalife, Watch Ackman’s Analysis and Read the Critics on his Thesis

Not so long ago I mentioned we should probably pay much more attention to short sellers.

Besides Chanos vs. HP there is another interesting battle unfolding: Ackman vs. Herbalife. Ackman stated he has over a billion USD invested in this short position and he said he’s donating his personal profits to charity.

At first glance, Herbalife never looked healthier, with Gross Margins around 80%! And Returns on Assets and Equity well into the double digits for years.

Herbalife FinancialsSource:

Ackman and his team at Pershing Square however have analyzed the company for two years and don’t think the financials add up. Watch and download their analysis here:

Gross Margin Compared HL

See also Ackman interviewed on CNBC:

And Ackman interviewed on Bloomberg:

Some critics of Ackman say: Herbalife runs a sustainable pyramid scheme.

“Here is where I believe Ackman may have made a strategic error. Short of an external force like the FTC or the SEC, there is nothing that stops Herbalife from profitably operating a pyramid scheme. The people targeted by Herbalife certainly do not read the financial press or read 343 slide presentations. There will always be a supply of uninformed victims for the Herbalife sustainable pyramid scheme. Herbalife is certainly not going to collapse under its own weight, given that it controls its diet of victims rigorously.”

Check the arguments here.

Herbalife reacted as follows: “Today’s presentation was a malicious attack on Herbalife’s business model based largely on outdated, distorted and inaccurate information. Herbalife operates with the highest ethical and quality standards, and our management and our board are constantly reviewing our business practices and products. Herbalife also hires independent, outside experts to ensure our operations are in full compliance with laws and regulations. Herbalife is not an illegal pyramid scheme.”

Now is Herbalife cooking the books or have Ackman and his team got it wrong this time? Judge for yourself.

Full Disclosure: I have no position in Herbalife

Why Should We Pay Attention to Short Sellers?

Generally short sellers are viewed as a force of evil, speculators, increasing the cost of government debt and endangering the confidence in listed financial institutions, hence causing systemic risk.

But Short Sellers Are Often Right!

Look for example at the developing story around Hewlett Packard (HP). Jim Chanos mentioned HP as a short candidate in June 2012. And now HP is in the midst of an accounting scandal. Who are the bad guys here? And how did he do it?

How did Chanos identify HP?

Chanos typically searches for problems instead of growth stories. He sees short candidates in roughly 4 areas of opportunity:

  1. Debt-financed booms that go bust
  2. Companies that are becoming technically obsolete, through creative destruction
  3. Bad accounting: from earnings overstatement to outright fraud
  4. Would be customer fads: extrapolation of one time success.

Chanos identified HP as a short candidate when they acquired Autonomy for a significant premium (see chart below). The acquisition and the price raised a red flag to Chanos. Chanos was short Autonomy at that time because of reason 3: bad accounting. We see now, for good reasons.

Source: Aswath Damodaran’s Blog: Musings on the Market

Autonomy was to Chanos another confirmation of HP’s dismal M&A track-record. Chanos, June 2012: “..Compaq impairment, EDS restructurings, Palm write-off, Autonomy revenue implosion…” 

HP has been hiding the true costs of its R&D through acquisitions. Once the costs of these acquisitions are taken into account, revenues and cash flow at the company are “basically flat,” Chanos said.

To make things worse, Chanos also detected the computing market is in decline (E.g. Computers with hard drives vs. Tablets and Cloud Computing) and HP had no strategy to move to new profitable high-grounds. It was just waiting for accidents to happen.

So HP dealt with problem number 2 and acquired problem number 3 through Autonomy. Definitely a short candidate!

What if more investors had made this analysis? Should we listen more often to short sellers? What can we learn from short sellers like Jim Chanos? How do short sellers perform their analysis?

Article: How Jim Chanos Spotted the HP Scandal

First, Some History on Short Sellers

Short sellers are with us since financial markets exist. Jenny Anderson of the New York Times notes in 2008:

“…In the days when square-rigged galleons plied the spice route to the East, the Dutch outlawed a band of rebels that they feared might plunder their new-found riches.  The troublemakers were neither Barbary pirates nor Spanish spies—they were certain traders on the stock exchange in Amsterdam. Their offence: shorting the shares of the Dutch East India Company, purportedly the first company in the world to issue stock. 

Short sellers, who sell assets like stocks in the hope that the price will fall, have been reviled ever since. England banned them for much of the 18th and 19th centuries. Napoleon deemed them enemies of the state. And Germany’s last Kaiser enlisted them to attack American markets (or so some Americans feared)…”

Enemies of the State or an Accounting Police?

Contrary to the general public and policymakers view, the investment world respects short sellers and views them as the most fundamental analysts, the smarter, more independent thinkers outside the herd. James Montier, a famous investment strategist at GMO classifies short sellers as follows:

“…the short sellers I have met are among the most fundamental-oriented analysts I have come across. These guys, by and large, really take their analysis seriously (and so they should since their downside is effectively unlimited). So the continued backlash against short sellers as rumour mongers and conspirators simply leaves me shaking my head in bewilderment.

I can only assume that the people making these claims are either policy-makers pandering to shorted companies, or shorted companies themselves. Rather than being seen as some malignant force within the markets, in my experience short sellers are closer to accounting police – a job that the SEC at one time considered its remit…”

Ok, ok: from Napoleon’s enemies of the state to the accounting police, now some facts please!

Yes, Short Sellers Identify Overpriced Companies…

Owen Lamont (2012) recently updated his 2003 study. He studied battles between short sellers and firms from 1977 to 2002.

He finds the following: firms that started fighting short sellers show a monthly underperformance of 2% (!), for the 12 months after a firm started the battle.

Lamont finds a 1 year cumulative return of  – 24% and a 3 year cumulative return of – 42%. Pretty serious negative returns.

…and Short Sellers Detect Fraud, Insider Trading and Earnings Manipulation

And believe me it gets worse. The sample studied by Lamont showed that the majority of the firms undertaking actions against short sellers are subsequently revealed to be fraudulent.

Karpoff and Lou (2010) find short sellers anticipate revelations of misrepresentations of financial statements, which are material events (average 1 day share price declines of 18%!).

They also see the amount of short selling increases with the severity of the misrepresentation indicating short sellers sniff-out fraud, insider trading and earnings manipulation rather systematically.

Again some convincing evidence short sellers speed up the time-to-discovery and help deflate overpriced shared due to misstated earnings.

Does this sound familiar? At least in this case the company (HP) has picked another scapegoat for the fraud: Autonomy’s former management. The short seller (Chanos) escapes a court case, for now. The pattern however is clear: the financials were materially misstated and a short seller pointed it out and now management is playing the blame game.

So Who Are These People?

So shouldn’t we study more carefully what short sellers say, rather than disqualifying them as malignant? Shouldn’t we watch their presentations and think about what their analysis implies for our investments? If we want to listen tot them we at least have to know who they are!

Let’s look at what Jim Chanos had to say recently:

We haven´t discussed him yet, but another famous short seller is David Einhorn. Yes, the short seller Dick Fuld (Lehman) wanted to crush. Luckily, gravity did its work and we can still enjoy Einhorn’s analyses:

Other short sellers are Gerorge Soros, John Paulson, Steve Eisman, Michael Burry, Jamie Mai etc.

So How Do Short Sellers Analyze Companies?

Of course there is more on Chanos and Einhorn and other short sellers. However I’ll leave that for later posts or your own research. I think it’s time to take a class on what short sellers’ generally look for in company financials.

In this Guest Lecture, Katrhyn Staley, writer of The Art of Short Sellingexplains how short sellers go to work. Pay attention and take notes.

As we’ve seen, it is a useful training for any investor.


Reading list:


Free online courses from Princeton, Stanford, Berkeley and more…

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About Coursera:

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Through this, we hope to give everyone access to the world-class education that has so far been available only to a select few. We want to empower people with education that will improve their lives, the lives of their families, and the communities they live in.”


Online Course Value Investing

I came across some very useful investment advices from valueinvestor- Warren Buffett, Peter Lynch, John Templeton, Seth Klarman, Charlie Munger, Walter Schloss, Bill Ackman, Bruce Greenwald, Martin Whitman, Whitney Tilson, Irving Kahn, John Bogle, Hersh Cohen, David Winters, Chris Davis, Roger Lowenstein, Irwin Michael, Mohnish Pabrai, Mark Holowesko, David Nadel, Tom Russo.

Thanks to a very informative blog on value investing:


GMO’s Jeremy Grantham Chief Investment Officer about asset managers at a Dutch pension fund: They’re worried about their career risk and not about the capital of the retirees …

Jeremy Grantham*: “… you can sit down with a great, sexy Dutch pension fund dripping with Ph.Ds, and you have lunch and you talk about risk 12 times, and each of the 12 times they did not mean the risk of the beneficiary, the pensioner losing money. They meant the risk of deviating from their precious benchmark and putting them into some career risk with their bosses. And nobody thinks of risk as the actual real risk to the beneficiary. It’s actually almost unethical….”

Jeremy Grantham*: “….Keynes described (80 yrs ago!) a row of bankers marching of the cliff together. He said as long as they make sure they’re all together, their careers are reasonably safe. That’s a pretty good description of ’08. If you wanted to lose your job, you had to do something spectacularly incompetent. Otherwise, you’re in decent shape”

Huang and Mahieu (2010) find that up to  ’06 on average, Dutch pension funds do not generate excess return relative to a predetermined benchmark. #

Are Dutch pensions safe in the hands of career minded asset managers?

* Morningstar Investment Conference 2012
# Large funds perform better than smaller funds.