Tobias Carlisle (TC): Today I have with me Brad Lamensdorf, who has an interesting background. He started his career in hedge funds working for the Bass family in Texas, ran his own partnership successfully for a number of years and then became a short seller helping to co-manage and launch the first actively managed bear ETF. But, recently you created an investment fund focusing on short squeezes. We’re going to dive into that today. But, first, Brad welcome.
Brad Lamensdorf (BL): Hi Tobias, it’s nice to be with you today.
TC: So, what’s interesting to me is how does a manager go from shorting stocks to focusing on short squeezes? The ActiveAlts Contrarian ETF (NASDAQ: SQZZ) is unique in this approach.
BL: Well, Tobias, no one knows more about a short squeeze than a short seller. I have been shorting stocks for over 25 years and through several market cycles I have seen it all. One of the main risks to a short seller is a squeeze. For those of you who don’t know, a short squeeze occurs when a stock is heavily bet against by short sellers. As they cram into the stock there’s a lot of selling pressure. They’ve now made their bet that something bad will happen with the company and push the stock down even more. However, the exact opposite occurs and good news forces these short sellers to run for cover. As they buy back the stock, it propels the stock price higher and higher. It may even go much higher than reasonably justified, simply because so many buyers enter the market as the shorts are covered. The good news can be anything: It might be great earnings or guidance. It could be a new joint venture. Maybe a new market opens up, or a killer product is released that’s a game changer.
Because I have seen this for nearly three decades, I decided to exploit these opportunities for profit rather than try to avoid them as a short seller.
I’m already doing work on heavily shorted stocks, both fundamentally and technically. In many instances, short sellers are right. Collectively, they do a good job of ferreting out problems with a stock. But, in my opinion, when they are wrong it creates one of the best opportunities to profit quickly in the marketplace.
TC: Can you talk a bit about the fundamental and technical process you use?
BL: I’m a bit of a William O’Neil type trader, with sentiment mixed in. I am looking for accumulation in a stock. Big institutions that are consistent buyers over time, will reveal clues in the price and volume relationships providing a footprint. The stock will start to pick up relative strength and will act better than the overall market.
On down days, for example, volume might be lighter and won’t fall as much as the major indexes. On up days, volume will likely be higher than average and the stock will typically outperform to the upside.
I also use a lot of charts and statistical analysis from institutional firms like Ned Davis Research. I also write a newsletter on LMTR.com where I publish some of these charts free of charge. So, you can have some really powerful data right at your fingertips.
Fundamentally, we want to make sure that the revenues are sustainable and that the company generates quality cash flows. There are a lot of tricks management can use to “pretty up” the earnings in any given quarter, masking a weakness in their business. So, earnings quality is a very important fundamental consideration.
Most short sellers are fundamentally driven. So, for sure we want to act as a check on their work. I think where they get led astray is when they short stocks due to valuation. An expensive stock can get more expensive. Or, they may mistakenly think the business model is “broken”. Companies evolve, and sometimes what looks broken may actually be the pathway to new products that really amp up the earnings power in future periods.
A constructive chart with good earnings quality is a set up that I favor.
TC: What’s an example of a short squeeze situation that you have been involved with recently?
BL: Sure. Weight Watchers International, Inc. (NYSE: WTW) in early 2017. The fundamentals started to bottom with the exception of revenue growth. Unlike most consumer stocks, the company had negative working capital. So, revenue was converting to cash quickly. Meanwhile, earnings quality improved as cash flow exceeded net income. There was virtually no inventory risk, so liquidations weren’t an issue.
A new CEO came on board which could be considered a red flag. However, he’s a deal guy. It was a positive because the company was coming back up and around fundamentally, started to show up in the stock price.
A lot of bears were concerned about leverage and the quality of the balance sheet. Well, not only were there no working capital issues, but they dismissed the biggest asset that the company possessed.
Oprah Winfrey!
She doesn’t show up on the balance sheet, but Oprah has near 100% name recognition and a sterling reputation.
At the time it also cost 20% annually to borrow the stock. It was a very crowded and expensive short. Meanwhile, the fundamental trends were improving and Oprah got involved.
TC: That’s an interesting point about Oprah being an intangible asset that doesn’t show up on the balance sheet. Have you ever shorted a stock and then taken a long position after the short thesis no longer presented an issue for a company?
BL: Yes, absolutely. Under Armour (NYSE: UAA) is an example. We shorted the stock in our short only ETF when the company had huge build up in inventory and accounts receivables. In addition, the company had cash flow warnings. Any slowdown was going to cause not only a slowing of growth, but also margin compression. My co-manager on the short fund, John Del Vecchio, had noted in his own forensic accounting software that Under Armour was the worst ranked stock in the model.
Then the company went through a tough time, and the stock price got crushed. Once a core holding, growth managers now saw all the air come out of the stock. This occurred quickly.
After the fall from grace, though, the stock settled at a price that seemed far too stretched to the downside. In my view, they weren’t going to go out of business. Inventories are still an issue, but management is laser focused on this. In addition, it doesn’t take much of a rebound in growth to get a massive expanse in margins.
Under Armour doesn’t need to become a core growth company again to see significant gains in its stock price, in my opinion. They just need to clean up the inventory situation a little bit. In addition, they have substantial amounts of data on the workout habits of their customers. This combined with innovative fabric technologies, could allow them to be more responsive to consumer demand in the future.
That data on hundreds of millions of people across billions of workouts is extremely valuable. The stock has started to turn up since the short thesis played out.
TC: What do you do if there aren’t enough compelling investment ideas at a particular time?
BL: I have the flexibility to adjust exposure as I see fit. While the stock picking is a bottom’s up process, I have a top down view about market exposure. For example if market sentiment is extremely bullish, then I want to be less aggressive on the long side, as that’s a contrary indicator.
My experience in hedge funds comes into play here. In the strategies that I managed we were never shy about holding cash. Obviously you may not pick the exact top in such a situation, but the odds favor any future gains totally evaporating until market sentiment reverts to normal levels.
I use a plethora of big picture indicators. There’s no sense being fully invested if you have a strong sense that market risks are high. Conversely, when the market is too stretched to the downside and investors have capitulated, I want to be all in on the long side. It’s very much a contrarian approach.
TC: That explains the name of the fund! Brad, thanks so much for your time today, and I look forward to following along with your strategies.
BL: You’re welcome, Tobias. Thanks for having me. Have a nice day.
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