Gamestop Corp’s (NYSE:GME) trading frenzy has again put short-sellers in the spotlight.
And true to form, they have again been portrayed somewhere in-between leeches and vampire bats on a scale of fauna-inspired metaphors.
Is this fair, though, and do short-sellers actually have a role to play in weeding out the over-valued, over-hyped or just downright fraudulent among listed companies?
READ: GameStop’s Reddit-inspired trading frenzy set for resurgence as Robinhood and other trading apps lift buying ban
Shorting essentially means selling shares that you don’t actually own with the aim of buying them back at a lower price and making a ‘turn’ on the difference.
It is a risky strategy as, in the way that hedge funds shorting GameStop have found this week, if the price goes against and you can’t close the trade, the losses are virtually limitless.
To avoid that risk, short specialists usually target companies with problems.
In the UK, for example, Cineworld (huge debts, and huge pandemic problems), fits the bill perfectly and it is among the most-shorted of the UK-listed companies.
But it is not always the most obvious companies that get the attention of short-sellers.
Middle East-focused healthcare group NMC was in the FTSE100 before US short-seller Muddy Waters issued a damning report criticising the finances of the business in December 2019.
Muddy Waters’ aim was spot on and NMC subsequently collapsed into administration amid a welter of undisclosed debts, fraud allegations, confusion over who owned it and unauthorised payments.
Barry Norris, chief executive of fund group Argonaut Capital, is a believer in the benefits of shorting and says the idea of a peasants revolt by retail investors against hedge fund suits is flawed.
Short selling in a bull market is not an easy living, he says, and although widely seen as malicious usually only succeeds if an unpalatable truth is discovered.
“Short sellers often unmask fraudulent management, as well as exposing poor business models.
“In unmasking an astonishingly brazen multi-billion-dollar fraud, some short sellers were even subject to threats to their personal safety and a questioning of their professional reputation.”
NMC Healthcare in the UK was similarly exposed, says Norris.
In a defence of the practice, Norris adds: “If there are no short sellers to play the role of market vigilante, we would inevitably have a more dishonest stock market.
“Without any ability for fund managers to hedge through short selling, fund buyers would be unfairly corralled into equity products reliant on upward market direction for returns.
“It is also important to point out that companies do not go bust when their share price falls, but when they run out of cash.
If GameStop now takes advantage of its extraordinary share price by selling new shares to fund the opening of even more stores selling video games would this really be the best use of any investors capital or in the long-term interests of the overall economy?”
After dropping over 40% yesterday, GameStop shares surged more than 60% higher as trading restarted in the US this afternoon to US$312.82, having started the year below US$20.