Pillars of Fundamental Short Selling

Franchises have extensive potential potential for financial stumbles; A short seller should look for types of business that eat money-financial services and real estate.

I. Financial statements checklist:
1. One should start with the most updated balance sheet, looking for bogus asset or assets for which the market value is less than the balance-sheet value. Examples are:

• securities not marked to market
• real estate with inflated values
• inventories with obsolete products
• receivables that have been booked too aggressively
• receivables with loss provisions too low
• bad loans
• Fuzzy, unbankable assets.

2. The AR and Inventory should be tested by looking at the change in AR and Inventory against changes in sales and CGS. For AR, note that the surge in AR may be simply related to acquisition.

3. Check for deferred charges (prepaid advertising, deferred commissions, etc.

4. Check for goodwill and intangibles to see if the company has overpaid for an acquisition or is failing to expense drilling costs or software development costs.

5. Check accumulated depreciation to see if AD drops when gross PP&E rises.

6. What are all nonrecurring gains? Is the company including them in operating income?

II Ratio Analysis

Long term debt to equity
Total debt to total capital
Total debt to equity
ROE ROA ROIC
PE, PS, PB, POCF
EBITDA/Interest


III Checklist of Proxy Questions

1. Are executives paid exorbitant salaries? Look at compensation relative to company earnings.
2. How is the bonus? Is the bonus tied to extraordinary efforts, or is it just for doing the job?
3. Does the company pay a % of percentage of pretax profits to the primary officers in the form of bonuses?
4. Stock grants vs stock options vs SARs-SARs are the most generous for the executives, followed by grants.
5. Does the company have an unusual severance pay contract, especially in case of merger or buy-out?