Short selling strategies risks and rewards phần 3 potx

70 THEORY AND EVIDENCE ON SHORT SELLING problem, bad luck that has temporarily depressed earnings, and so on). Virtually never will a firm publicize facts like the obsolescence of their products, the products’ lack of durability, or the stupidity (or senility) of their management. Just imagine what the sales reps for the competition could do with statements such as “Competitor X has a better product,” “Our product is obsolete,” or “We have found unexpected durability problems with our product.” A plaintiff’s lawyer would love to have a statement on record saying, “Our product is unsafe.” If analysts or brokers identify a stock that is underpriced, they can be expected to publicize the information that make them believe it is under- valued. They, and their firm, could get an order to purchase the stock by informing investors of the information. Just as an example, a recent news story states, “Keane’s nod carries some punch as his advice reaches 12,000 retail stock brokers at Wachovia Securities.” 11 If each broker keeps only nine investors informed, the word has reached 108,000 inves- tors, more than the 100,000 investors discussed above. In contrast, even when short selling is allowed, few investors will place short sale orders. Only a few investors will own any given stock, so phone calls saying the stock is over valued will typically be greeted with “That’s interesting, but I don’t own any.” In many cases, if the stock is actually owned, it is because the broker making the call sold it to the investor. There are real problems in calling a client up and explaining why the stock you previously urged him to buy should now be sold. Even those who own a stock are unhappy at brokers and ana- lysts who draw attention to a stock’s problems, since this forces its price down, making current owners poorer. The current owner usually has an ego investment in the stocks he owns, and telling him that these stocks are overvalued is to question his good judgment. The brokerage firms that employ analysts are also investment bank- ing firms that bring out new issues. Publicizing bad news about a firm does not help attract investment banking business from that firm. Other investors (once they have accumulated a position) have an incentive to publicize the case for making an investment. If others fol- low them, the price may be bid up, making their own positions more profitable. The quicker any underpricing is eliminated by others learn- ing of the investment’s merits, the quicker profits can be taken (i.e., the higher the annualized rate of return from the investment) and the funds invested elsewhere. Also, it is pleasant at social gatherings to demon- strate your brilliance by talking about why the stock you just bought is 11 Mark Davis, “Local Stocks: Analyst’s Optimistic Rating Pushes Up DST Stock,” The Kansas City Star Web site (September 30, 2003), posted at http://www.kansascity.com/ mld/kansascity/business/6891701.htm. 5-Miller-Restrictions Page 70 Thursday, August 5, 2004 11:10 AM Restrictions on Short Selling and Exploitable Opportunities for Investors 71 a good buy. Admittedly, short sellers have the same incentive to publi- cize negative information, but because there are so few of them relative to the longs (see above), their impact is much less. Even the press is likely to assist in eliminating underpricing. Most business press stories are inspired by press releases. It is much easier to take a press release and write a story out of it than to do investigative work from scratch. Negative stories often eliminate the cooperation from the company that is needed for future stories. Because of the incen- tive that companies have to raise their stock prices, their press releases and the stories based on them have an optimistic bias. The disincentive to publicize bad news has been offered as one rea- son for the profitability of momentum strategies. 12 There is also a behavioral aspect here. Investors are reluctant to admit to themselves, their spouses, or their bosses that they have made a bad investment. Selling a stock means admitting to a mistake. A much better psychological strategy (even if a bad investment strategy) is to find reasons why the stock that has gone down is still a good investment and will come back. One study found that stocks above their purchase price are 50% more likely to be sold than stocks that are below their purchase prices. 13 Because of this bias, more analytic attention to stocks where there is not obvious bad news may unearth publicly available information that can be acted on profitably. The information may have been disseminating slowly enough so that prices have not fully adjusted yet. A stock that has fallen without an obvious explanation may be one that should be looked into further. When we combine the obstacles to short selling with the asymmetry in the ease with which positive versus negative information is dissemi- nated, we discover that there will be very few grossly underpriced secu- rities that can be discovered from publicly available information, while there will be some overpriced securities that can be identified. As will be seen below, this observation has strong implications for investment strategy and for how a firm should allocate its analytical resources. Accounting Implications The above argument shows how in the absence of short selling, mistakes on the high side (those which cause investors to raise their estimate of the value of a stock) tend to raise stock prices, while those on the negative side do not. Thus there is an important asymmetry here. Accounting conven- 12 Harrison Hong, Terence Lim, and Jeremy Stein, “Bad News Travels Slowly: Size, Analyst Coverage, and the Profitability of Momentum Strategies,” Journal of Fi- nance (February 2000), pp. 265–295. 13 Terrance Odean, “Are Investors Reluctant to realize Their Losses?” Journal of Fi- nance (October 1998), p. 1786. 5-Miller-Restrictions Page 71 Thursday, August 5, 2004 11:10 AM 72 THEORY AND EVIDENCE ON SHORT SELLING tions which cause naive investors to overestimate the value of the company do more harm than those which cause naive investors to underestimate a stock’s value. This analysis of investing as a loser’s game provides an argu- ment for conservative accounting. 14 Probably the most important number for investors that comes out of the accounting process is earnings per share. This argument suggests that conventions that often overstate earnings should be avoided even if alter- native conventions understate earnings. Overstated earnings often lead to overpriced stocks. Even if many analysts understand the true situa- tion, there are likely to be enough who are misled for the stock to be overpriced. In contrast, suppose a convention produces misleadingly low earnings, but the information is available to compute a better measure. In this case, there are likely to be enough analysts who recognize the true situation for the price to reflect their evaluations. It follows that errors that understate earnings are likely to be less damaging than errors that overstate earnings. Thus, when a rule cannot be devised that is certain to be correct, it is probably best to err on the conservative side. There is a social cost from stock prices that do not reflect value. Calculated costs of capital are partially based on their stock price. 15 Hence, if the stock is overpriced, then the cost of capital for that firm will be underestimated, and the firm may overinvest. If stock in a partic- ular industry becomes overvalued (as happened with Internet stocks during the late 1990s), there may be overinvestment. Capital can be eas- ily attracted when stock prices are high. Thus, the conclusion is that accounting methods should be biased towards the conservative side. As an example, consider whether to expense an item such as research or to permit it to be capitalized. Although it is recognized that most research will be valuable over a number of years, it is difficult to know how many years. This difficulty has kept research from being capitalized and then amortized. Suppose a firm was free to amortize research expen- ditures over a number of years, even if the research had yielded very lit- tle. This would make the reported profits higher. Some investors might realize the research had yielded little, and value the company at a lower price. However, there would probably be enough investors who took the company’s accounting at face value for the stock price to reflect their higher valuations. However, if the research is expensed when done (the current procedure), there will probably be some investors who do not realize the research expenditures have long-term value. However, there 14 Edward M. Miller, “Why Overstated Earnings Affect Stock Prices But not the Re- verse,” Journal of Accounting, Auditing, and Finance (Fall 1980), pp. 6–19. 15 See a standard text such as Anthony F. Herbst, Capital Asset Investment (New York: John Wiley & Sons, 2002). 5-Miller-Restrictions Page 72 Thursday, August 5, 2004 11:10 AM Restrictions on Short Selling and Exploitable Opportunities for Investors 73 are likely to be enough investors who recognize the value of the research (or at least intelligently estimate it), to raise the firm’s stock price. These investors will be the optimists who set prices. An example can be provided by convertible bonds. The drug com- pany, Cephalon, issued convertible bonds with a zero interest rate. Why would anyone buy bonds that do not yield anything? The answer is that the conversion option is valuable. Cephalon’s stock price could go up a lot, especially if its antidrowsiness drug, Provigil, is approved for new uses. Since the proceeds from the bond sales will be invested at a profit, the earnings per share should go up. If the bond holders get a valuable conversion option from the convertible feature, should not that be reflected in the accounts? A little background may be useful. At one time the earnings per share for stocks were based just on the number of shares outstanding. This was misleading because there would be more shares outstanding if the con- vertible securities were converted. Firms could get their earning per share up by selling convertible securities and using the proceeds to purchase profit-earning assets (or using convertible securities to buy other compa- nies). The interest charges were low because of the conversion feature. However, until converted there was no dilution on the books. Investors tended not to convert till required because of the lower risk of bonds than equity, and the fact that the interest rate usually exceeded the dividend rate (which was often near zero). The ability of outstanding convertible bonds to raise stock prices was eventually reduced by requiring earnings per share to be reported on a fully diluted basis. Does making a conversion adjustment in the accounting affect the stock price? Many would argue that it should not because investors can find out about the convertible securities and calculate their own numbers. If the accountants did not do the calculation, surely many, perhaps most (weighted by size of portfolio), investors would do so. If investors make such adjustments, the price will reflect the adjustment. It then appears that what the accounting rules will have little impact on the stock price or economic efficiency. However, the above analysis with restricted short selling makes it very likely the accounting treatment will make a difference. Due to lack of time or lack of skill, there are many investors who will not make the required adjustments for potential dilution. Thus presenting diluted earnings per share earnings will be useful. A more complex example is provided by the current controversy over contingent convertible bonds. 16 These are convertible bonds that provide 16 David Henry, “The Latest Magic in Corporate Finance,” Business Week (Septem- ber 8, 2003), pp. 88–89. 5-Miller-Restrictions Page 73 Thursday, August 5, 2004 11:10 AM 74 THEORY AND EVIDENCE ON SHORT SELLING for conversion only if a contingency has occurred, such as the price reach- ing a considerably higher value than the conversion value. Under stan- dard accounting rules, the earnings per share are adjusted for full conversion of convertible securities that could be converted. However, with a high contingent price that must first be reached, this conversion need not be reflected in the accounts until the higher price is reached. With contingent convertible bonds, the conversion adjustment is avoided until the contingency occurs, which is usually further in the future. For recent Cephalon contingent convertible bonds, there was a potential 15% dilution. Failure to make allowance for dilution makes a stock appear more attractive. The investors who fail to make the adjustments will be the optimistic investors that tend to set the price. This applied to the original question of whether to make any adjustments for potential dilution and to the current issue of whether firms should be allowed to avoid adjusting for dilution when a contingency provision is involved. Another example is the current controversy over whether and how to expense employee options. Clearly these options are of value to employees and frequently are used in recruiting and retaining valued employees. Employees consider them part of the compensation package. It is also clear that they typically cost the shareholders something through potential dilu- tion. If they could be easily valued, there would be no dispute about the desirability of including them as an expense. However, there is consider- able dispute about how to value them and agreement that any formula will be frequently misleading. For instance, Hewlett-Packard claimed that its profits would have been cut 64% had it treated stock options paid to employees and executives as a compensation expense, while Cisco Systems said the proposed rule would have reduced 2002 earnings 80%. 17 There will be some investors who fail to recognize that the profitability of firms making heavy use of options for compensation is overstated. These investors will be willing to pay more for the stocks in question. They are likely to be overrepresented among the optimistic investors who set the price. Now suppose a conservative formula was used that often overstated the value of the compensation. Many informed investors would recognize the understatement of income. These more optimistic investors would be the price-setting investors. Thus, this argument suggests that, if the goal is to have market prices reflect values, we would include the cost of options as employee compensation. Admittedly, those that think technology (espe- cially startup firms) should be encouraged (at the expense of the less informed investors) oppose option expensing. Thus, the obstacles to short selling even have implications for accounting. 17 “FASB Delays Stock-Option Proposal,” Mercury News Wire Services (September 12, 2003), Posted at http://www.bayarea.com/mld/mercurynews/business/6753519.htm. 5-Miller-Restrictions Page 74 Thursday, August 5, 2004 11:10 AM Restrictions on Short Selling and Exploitable Opportunities for Investors 75 THE PATTERN OF STOCK PRICES OVER TIME WITH UNINFORMED INVESTORS The previous section used demand and supply curves to make some sim- ple points about markets with no short selling. Of necessity such a dis- cussion leaves out the time dimension. It is also a little extreme. In the United States short selling is legal, even if relatively rare (but remember there are many markets where short selling is forbidden). Although in the United States short selling is possible, it is not nearly as simple as many mathematical models would make it. In these models, short posi- tions are equivalent to long positions with a negative sign. Someone who sells short can just take the money and invest it elsewhere (just as someone with a long position can sell it and invest the funds elsewhere). This, of course, is not what really happens in a short sale. The lender of the stock which is sold short needs assurance that the stock will be returned. This is traditionally done by providing a cash deposit equal to the value of the stock sold short (and marked to market as its price changes). For most individuals, no interest is paid on these proceeds (the cases where interest is paid will be discussed later). Con- sidering this case provides some useful insights. The simplest case can be shown with the aid of Exhibit 5.3. Suppose there is a nondividend paying company that is going to liquidate at a EXHIBIT 5.3 Price Limits when Short Sellers Receive No Interest on the Proceeds 5-Miller-Restrictions Page 75 Thursday, August 5, 2004 11:10 AM 76 THEORY AND EVIDENCE ON SHORT SELLING future date, say 2010. One might imagine it as a mining company that will liquidate when the deposit is exhausted (or when it’s right to mine the deposit lapses). The well-informed investors analyze the company and estimate the liquidating dividend, C, in the exhibit. To decide how much to pay for the security, the informed investors discount this liqui- dating dividend at the appropriate risk-adjusted rate, and arrive at a value for each earlier date. Curve BC shows this price as a function of time. An informed investor should follow a simple rule: Buy the stock if its price is less than the value on line BC. The logic is simple. When the security can be bought at a price below BC, it is priced to yield more than other securities of equivalent risk. It is easy to argue that in a market with many well-informed inves- tors that the price will never fall below the line BC. This is because if it did, the informed investors would place buy orders for the stock and bid it back up to the line BC. If all investors were well informed, it would be obvious that the prices at all times would be on the line. But as pointed out earlier, there are likely to be quite a few badly informed investors. A harder problem is whether the price could be held above the line by uninformed investors. The textbook answer to the problem of uninformed investors possi- bly bidding the price up is similar to why the price could not be below the line BC. Just as informed investors would buy if it was below the line, informed investors would sell if it was above. This selling would force the price back to the line. However, the argument has a flaw. The informed investors may not even own the stock they predicted to sell. If there are no informed inves- tors who own the stock, how could selling by informed investors force the price down to the right level? This counter argument is usually met with a casual assertion that a stock not owned would be sold short. The rule for profiting in short selling is the same as for profiting from going long, “buy low, sell high.” When an investor fails to receive prompt use of the proceeds, a short sale is profitable only if the stock can be sold now for more than the cost of later repurchas- ing it. Under the best of conditions (where the short seller can put up stocks already owned as margin and there are no dividends being paid), only stocks anticipated to decline in price are profitable short sales. Now consider a stock below line AC but above the lower line, say at point D. Since price D is below the liquidation price, purchasing and holding the stock till liquidation will prove profitable. However, since line BC was calculated to yield a normal (risk-adjusted return), any stock above that line will yield a below market return. For concreteness, imagine stock D is priced to yield 1% per year. This clearly should not be held since the investor can do better with other assets. 5-Miller-Restrictions Page 76 Thursday, August 5, 2004 11:10 AM Restrictions on Short Selling and Exploitable Opportunities for Investors 77 With reason this stock can be said to be overpriced. Although many defenders of the efficient market hypothesis assert overpriced stocks are short sales candidates, this stock is not a short sale candidate. Because stock E will rise in price, it is not a short sale candidate. Investors lose money by shorting stocks that subsequently rise in price. The advice, “buy low, sell high,” applies to short sales. The example points out that an overpriced stock is not necessarily a short sale candidate. This is a mistake frequently made by efficient mar- ket proponents who casually assert that overpriced stocks will be sold short. (The usual definition of an overpriced stock is one that is expected to have a return below that on securities of comparable risk.) Sometimes short selling is plausible. If the price is above line AC, informed investors could potentially short the stock and make a profit. Since line AC is the liquidation price, a stock sold now and bought back just before the company is liquidated would be profitable (if there are no carrying costs for the short sale). Of course, there could be a wild ride before the profit was realized. Notice is that the upper limit (set by short selling) and the lower limit (set by buying) can be quite far apart. The lines are far apart when there will be several years before the uncertainty about the true value is resolved (which happens here when the company is liquidated). Between the two lines, the rule for informed investors is “sell, if owned.” Since line BC shows the price increase required for the stock to show a normal return, if the price is above this line, the appreciation will be below that needed to justify holding it. Thus, the stock should be sold if owned. Admittedly, whether or not short sales of overpriced stocks are made is not critical as long as investors are considered to all have the same expectations (homogeneous expectations). If all investors agreed that a fair price for the stock lay along the curve BC, they would regard any price above the line as a signal to sell the stock, and their selling would force the price back to the line. Thus, with homogeneous expec- tations (which textbooks tend to assume), efficient market pricing is insured regardless of the institutional arrangements for short selling. Pricing with Uninformed Investors The argument presented above needs not hold if there are some unin- formed investors. Suppose many investors believe the liquidating divi- dend will be E. Their current willingness to pay will be D (i.e., the present value of E). If there are enough such investors to absorb the entire supply, the market price will be D. As the price rises above B, the informed sell to the less informed. The informed investors drop out of 5-Miller-Restrictions Page 77 Thursday, August 5, 2004 11:10 AM 78 THEORY AND EVIDENCE ON SHORT SELLING the market once their stock holdings are exhausted, and competition among the optimistic investors bids the price up to D. As long as there are sufficient overoptimistic investors, the price will be at D. A sufficient number of overoptimistic investors need not be a very high number. For instance, if the company has 100 million shares outstanding and each investor typically takes 1,000 shares, only 100,000 investors need be optimistic about the stock to sustain the price at D. If there are a total of 10 million investors in the economy, this would require that only 1% be overoptimistic for the stock to be overpriced. The above argument shows that in the presence of uninformed investors, there could be some overpriced stocks that could be identified by analysis of publicly available information, contrary to a well known implication of the efficient markets hypothesis. This is the same conclu- sion that was reached earlier, but now we are showing it holds even if all investors are able to sell short, but are required to surrender the pro- ceeds of the shorts sale as a security deposit on which they do not earn interest, a situation that is true for most individual investors. Investors Who Can Receive Use of the Proceeds Up to this point, the theory has been developed on the assumption that investors can never receive use of the proceeds of a short sale. This is the situation for most individual investors. However, in the United States this rests on custom, not legal prohibition. Institutions and brokerage houses can frequently borrow certificates using procedures that give them some return on the proceeds. As a practical matter, the ability of the institutions to borrow shares under circumstances where they receive part of the pro- ceeds is of only limited importance, since most institutions are operating under constraints that prevent short selling. However, some institutions (such as hedge funds, long–short investment companies, certain mutual funds, and other investment companies) may sell short and other large players (brokerage houses) may arrange to receive a return on the pro- ceeds of a short sale. Thus this case should be considered. There are several procedures that permit receiving some return on the security provided against loan of the certificates Hanson and Kopprasch once reported 75% of brokers’ call is standard. 18 In other cases, borrow- ers of the shares deposit either other securities as security (in which case the return on these securities is still available to the short seller), or a bank letter of credit. They pay the lender an explicit fee for each day the shares are loaned. This fee offsets the earnings from the proceeds, in 18 See H. Nicholas Hanson and Robert W. Kopprasch, “Pricing of Stock Index Fu- tures,” in Frank J. Fabozzi and Gregory M. Kipnis (eds.), Stock Index Futures (Homewood, IL: Dow Jones-Irwin, 1984) pp. 72–73. 5-Miller-Restrictions Page 78 Thursday, August 5, 2004 11:10 AM Restrictions on Short Selling and Exploitable Opportunities for Investors 79 effect causing the proceeds to earn less than the market rate. Much of the lending apparently comes from index funds that maintain a large inven- tory of most securities and are more than happy to get some incremental revenue from lending securities. Securities that are not held by index funds, or for which there is a heavy demand for shorting, will be harder to borrow, and the interest an institution receives will be less. In some cases, it may be necessary to pay a per day fee to borrow a scarce stock. D’Avolio got data from one of the largest lenders of securities in the world for the period from April 2000 to September 2001. 19 The bor- rowers of the stock were usually brokerage firms borrowing either for themselves or for institutional short sellers (hedge funds, short selling funds, long-short funds). The collateral for borrowing is cash 98% of the time (the rest of the time it is Treasury securities). In most cases, this security lender paid interest on this collateral at a rate that is referred to in the industry as the rebate rate. As noted above, this rebate is not nor- mally passed on to the retail customer. On “nuisance loans” for under $100,000 in securities, no rebate was paid. D’Avolio calculated an implicit fee as the difference between the Federal funds rate and the rebate rate. In the few cases where Treasury securities were used as col- lateral, an explicit fee would be charged. For most stocks, the implicit fees were always under 1%. In a few cases, there is a shortage of shares to be borrowed and the implicit fees are higher. These stocks are referred to as being on “special” by practitioners. In even fewer cases, the implicit fee is large enough so the rebate rate is negative. The inter- est earned varies according to demand and supply for the securities. The majority of stocks (91%) were not on special (referred to as “general collateral”) on any given day. For these stocks the value- weighted mean fee was only 17 basis points per year. The vast majority of the dollar value of stocks appeared to be available for borrowing. For most of these stocks, the borrowing would be done at a nominal fee. The stocks that appeared to be possibly unavailable (i.e., not listed by this lender), tended to be very low capitalization stocks and often too small or too low priced to be of institutional interest. (Since most lend- ing was coming from institutions, this is not surprising.) On average 8.75% of stock loans were specified as “special.” The value-weighted mean loan fee was much higher, at 4.69%. There was an average of six stocks on any given day for which the rebate rate was negative (i.e., the borrower of the stock did not receive interest on the collateral and had to pay money to the lender as well). For these, the 19 Gene D’Avolio, “The Market for Borrowing Stock,” Journal of Financial Eco- nomics (2002), pp. 271–306. 5-Miller-Restrictions Page 79 Thursday, August 5, 2004 11:10 AM [...]... Keim, “Size Related Anomalies and Stock Return Seasonality: Further Empirical Evidence,” Journal of Financial Economics (June 19 83) , pp 13 32 32 Ivan L Lustig and Philip A Leinbach, “The Small Firm Effect,” Financial Analysts Journal (May/June 19 83) , pp 46–49 Restrictions on Short Selling and Exploitable Opportunities for Investors 93 universe, selling the S&P 500 short in 1 931 would be the strategy for... such short selling opportunities suggests that there is merit to the idea of hedge funds (which try to take both long and short positions), and to mutual funds that take both long and short positions Restrictions on Short Selling and Exploitable Opportunities for Investors 91 While a single short sale is risky, the addition of a short position to the typical institutional portfolio reduces total risks. .. Venezuela, and Zimbabwe In another group of countries short selling was prohibited for some period during the 1990s These included Hong Kong, Norway, Sweden, Malaysia, and Thailand Then there was a group of countries where short selling was allowed but apparently rarely practiced, including Argentina, 86 THEORY AND EVIDENCE ON SHORT SELLING Brazil, Chile, Finland, India, Israel, New Zealand, the Philippines,... Financial Economics (19 93) pp 3 56; and Eugene F Fama and Kenneth R French, “Value Versus Growth: The International Evidence,” Journal of Finance (December 1998), pp 1975–1999 36 Narasimhan Jegadeesh and Sheridan Titman, “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency,” Journal of Finance (March 19 93) , pp 65–91 94 THEORY AND EVIDENCE ON SHORT SELLING Implications... large stocks were overvalued and shorted them would have lost money Similar comments could be made for the use of momentum variables, and for many other variables which have been shown to have some longterm predictive power .36 33 Avner Arbel, Steven Carvell, and Paul Strebel, “Giraffes, Institutions and Neglected Firms,” Financial Analysts Journal (May/June 19 83) , pp 57– 63 34 See S Basu, “Investment... Portfolio Management (Winter 19 93) , pp 13 24 48 Fuller, Huberts, and Levinson, “Returns to E/P Strategies, Higgledy Piggledy Growth: Analysts’ Forecast Errors, and Omitted Risk Factors.” 49 W Scott Bauman and Richard Dowen, “Growth Projections and Common Stock Returns,” Financial Analysts Journal (July/August 1988), pp 79–80 102 THEORY AND EVIDENCE ON SHORT SELLING growth (3 5 years forward) were actually... This lowers the profits for taxable investors and is one more obstacle to taking long-term short positions Legal obstacles should not be forgotten In many countries short sales are prohibited In Chapter 13, Bris, Goetzmann, and Zhu provide a table showing which countries permit short selling and some details As of December 2001 the countries prohibiting short selling included Colombia, Greece, Indonesia,... use of the proceeds, and they are likely to have the analytical talent and expertise to identify good short candidates, individual investors who do not get use of the proceeds (or get even worse terms) should be very careful about short selling It is plausible that competition between the hedge funds and other institutional investors has reduced the rate of return on short selling candidates to a negative... placing long-term short bets unattractive Restrictions on Short Selling and Exploitable Opportunities for Investors 89 The implication in Exhibit 5 .3 that investors would short sell any stock whose price exceeds AC leaves out dividends In the example, a stock that is certain to be selling for slightly less than it is selling for today would be sold short If the stock is dividend paying, the short sellers... of the company and about the dividends to be paid well after 2010 This infinite life makes short selling riskier, and implies that short positions will seldom be entered into for stock believed to be overvalued except when the overvaluation is very extreme and the holding period is short To a professional fund manager, the idea expressed in Exhibit 5 .3 that a stock would be a short sale candidate because . 5, 2004 11:10 AM 86 THEORY AND EVIDENCE ON SHORT SELLING Brazil, Chile, Finland, India, Israel, New Zealand, the Philippines, Poland, Spain, and Turkey. In China the short sales restrictions are binding. extreme and the holding period is short. To a professional fund manager, the idea expressed in Exhibit 5 .3 that a stock would be a short sale candidate because it could be sold short now for $101, and. overpriced stocks are short sales candidates, this stock is not a short sale candidate. Because stock E will rise in price, it is not a short sale candidate. Investors lose money by shorting stocks