I’m amazed it took this long…
After all, Facebook has been around since 2004… Reddit since 2005… and Twitter since 2006.
These platforms have existed for the last decade as forums for millions to share interests… as well as healthy and very unhealthy discourse.
But finally, retail investors have figured out how to use social media to band together and profit from one of Wall Street’s oldest moves – the short sell.
Short selling is not as straightforward as we might think… There is actually a lot of nuance. And investors who aren’t aware of the mechanics ultimately end up stacking the deck against themselves.
That said, there is nothing sinister about short selling. I would argue that it is a necessity – a vital dynamic of capital markets. Short selling helps keep asset values in check.
When a stock gets ridiculously overvalued, short sellers step in to sell the stock with the expectation that it will return to a more reasonable valuation.
Hedge funds focused on short selling often uncover accounting fraud or other corporate shenanigans that reveal that a company isn’t quite what it represents itself to be. In this regard, short sellers do a great service to the markets and those who invest in them.
But there are some critical elements of short selling that normal investors should understand…
When we sell a stock short, we are borrowing shares, selling them, and creating a liability. We have to buy back the shares we sold at some point to return them to the lender. Ideally, we’re buying back at a price lower than what we borrowed. If so, we make a profit… maybe.
Every short sale is done on margin and requires a margin account. And as there is a lender, there is a cost to borrowing. Stocks that are considered easy to borrow – think large, highly liquid stocks – might have an annual margin interest rate of 5%.
But “hard to borrow” stocks can have a margin interest rate of 20% or more. That is why profit is a “maybe.” A successful short sale has to be timed well, and the stock’s drop has to be large enough to cover what we paid in margin interest.
But it gets worse. Here is what most won’t tell you…
When we short shares of a stock that pays a dividend, we have to pay the dividend to the person who bought the shares that we sold. It comes right out of our brokerage account automatically.
The lender of our shares can call those shares back at the time of their choosing. This is where retail investors can really get screwed. We don’t have the kind of leverage that a fund does to preserve our position.
For example, let’s say that we sold $20,000 worth of shares in a terrible company that was being hyped up, but we believed that it was a fraud. The stock then runs up 40% leading into the company’s earnings announcement.
We’re not worried because we are certain the results will be terrible, and the stock will collapse. But the day before the earnings announcement, the broker that lent us the stock calls the shares back and we take a 40% loss ($8,000)… plus whatever margin interest we paid and any commissions. The next day, the stock collapses.
Not only are we in the hole $8,000, but we also missed out on a big profit. It isn’t right or fair, but it is perfectly legal. It has even happened to me.
The size of our potential losses is technically unlimited. Short sellers of Tesla learned this painfully over the last couple of years. Tesla’s stock has soared more than 20x. Can you imagine losing multiples of the amount that you received selling shares short? That has to hurt.
This is why my general advice to investors is to avoid short selling entirely. There are simply too many dynamics that favor Wall Street.
There are, however, bearish ETFs and funds that we can buy if we think the market is going to drop. This limits our downside greatly even if our timing is wrong.
Options are another alternative. We can buy puts on stocks that we think are destined to fall. The most we can lose on a put is the cost of the option, which controls our downside.
All this leads me back to the excitement of GameStop and how Wall Street sold short the stock.
Unlike what I outlined above – legal short selling – this was “naked” short selling. The brokers lent out shares of stock that didn’t exist. It should be impossible, but it happens all the time. And it typically results in large price distortions that favor Wall Street and hedge funds.
GameStop was an exception.
And now WallStreetBets has 8.4 million followers.
As a result, Citron Research, a firm that has profited off of short selling for the last two decades, got taken out to the woodshed on the GameStop trade.
Firms like Citron quietly establish short positions at the best prices and then publish damning research on the company. They make TV appearances and try to drive the stock down. But Citron got burnt so badly on GameStop that it just announced it will discontinue publishing short selling research.
The game is up.
Hedge funds now know that grossly distorted short positions will be recognized by groups of retail investors who can cause a short squeeze in a matter of days or hours… with the potential loss of billions for funds.
Now investment banks like Jefferies and Wells Fargo are even publishing lists of companies that are heavily shorted and are candidates for short squeezes.
That’s exactly how free markets should work.
And one last note before we turn to the rest of today’s Bleeding Edge…
Don’t forget to mark your calendar for our Investment Accelerator event taking place next Wednesday evening at 8 p.m. ET. I can’t wait for this one.
At the event, I am going to bring viewers up to speed on what I believe is my most ambitious project to date. We’re going to talk about a rare opportunity to join a top-tier group of investors for the chance to share in $1 billion in tech profits.
I will also share what we are most excited about right now here at Brownstone Research. And I will outline what I see as the five best investment opportunities that could 10x our money over the next five years.
I know the world and the markets seem chaotic right now. Many people are worried about the future.
But I’m not one of them.
While I acknowledge the problems as I see them – as regular readers well know – I see immense opportunity in a number of areas right now.
In fact, all the uncertainty that’s prevalent today is creating the perfect climate for tech-savvy investors. Those who can tune out the day-to-day noise and focus on the big picture will do very well in the years to come.
And that’s what our Investment Accelerator event is all about. The market is giving us a tremendous opportunity to turbocharge our investment returns right now. Let’s make sure we take advantage of it.
So please join me on Wednesday, February 10, at 8 p.m. ET sharp. We have a big night planned.
Now let’s turn to today’s insights…
Coinbase is circumventing the investment banks with a direct listing…
We talked last July about how Coinbase was in the process of filing to go public.
At the time, the industry assumed that this would be a traditional initial public offering (IPO) brokered by the large investment banks. But in an exciting twist, Coinbase just announced that it will bypass the banks and do a direct listing on the Nasdaq.
Bleeding Edge readers know that IPOs are controlled by the investment banks. The banks shop the IPO to large institutional investors, set the price, and allocate pre-IPO shares behind closed doors. Highly desired shares always go to the banks’ most valuable customers first. The scraps, if any, are left for normal investors to fight over.
The investment banks typically underprice the IPO. As a result, the company going public raises less capital… and the insiders make out like bandits with an artificially low price on the stock.
A direct listing circumvents that entire process.
With a direct listing, the company just lists a portion of its existing shares for trading. Then existing shareholders can sell their shares on the public market, and normal investors can buy those shares.
However, a direct listing prohibits companies from issuing new shares to raise capital when they go public. That’s why so few companies go this route. In fact, only a small number of companies like Spotify, Slack, and Palantir preceded Coinbase in doing a direct listing.
Regular readers may remember that the Securities and Exchange Commission (SEC) did just approve the New York Stock Exchange’s (NYSE) application to allow companies to do a direct listing and issue new shares at the same time. We talked about that last month.
But that was just for direct listings on the NYSE. By listing on the Nasdaq, Coinbase is giving up the ability to raise additional capital as it goes public. That tells us a lot about the health of its business.
Coinbase clearly has plenty of working capital already, and it believes that its brand name is widely known. Thus it doesn’t need to raise money at the time of the IPO. That isn’t really the purpose of the company going public. And it doesn’t need the banks to drum up interest in its stock listing.
That makes sense.
Many may not realize this, but Coinbase is the largest brokerage firm in the world in terms of its customer base. Coinbase revealed that it now has more than 43 million users across 100 countries.
In comparison to traditional brokerages, Fidelity maintains 30.8 million customer accounts, Charles Schwab hosts 12.3 million accounts, TD Ameritrade maintains more than 11 million accounts, and E-Trade has 5.2 million customer accounts.
The difference here is that Coinbase deals with digital assets and cryptocurrencies, not equities.
Coinbase’s last known valuation was $8 billion after its Series E funding round back in October 2018. The company is rumored to now be worth up to $30 billion. And I am confident that Coinbase will list its shares at an even higher valuation. I wouldn’t be surprised to see Coinbase trade in the $70 – 100 billion range this year.
That’s because there are very few publicly traded blockchain companies out there. And none of them are as large and credible as Coinbase. Coinbase’s direct listing legitimizes the industry. And investors will want to get in on the action.
So this is a watershed moment for blockchain technology and digital assets.
As a public company, Coinbase will file quarterly reports which will provide transparency about the financial health of the company. That will cause the financial services industry to take firms like Coinbase more seriously. It will inform better discussions with regulators. And it will open the door to cryptocurrency ETFs being approved for all investors. All great things for the industry.
That said, we should be very cautious any time we see companies going public at elevated valuations. If I’m right about Coinbase’s valuation after the direct listing has taken place, then investors would be wise to wait for a pullback before investing in the company.
As I have said many times, investing isn’t as simple as buying great companies. The trick is to get in at great valuations with plenty of growth ahead. That’s the difference between pure speculation and investing.
SpaceX’s master plan is coming into view…
SpaceX successfully launched 143 satellites into low-Earth orbit on a single rocket. This included satellites for its Starlink constellation as well as payloads for private launches.
This landmark event shattered the record for the most satellites delivered to space in a single launch. The previous record was 104 satellites launched by India’s Polar Satellite Launch Vehicle in 2017.
And there’s more to this story…
Starlink has been a popular subject in The Bleeding Edge. The company’s stated goal is to create a satellite network around the Earth that can provide internet access to anywhere on the planet. But I have always predicted that the real goal is to create a backhaul communications network for space.
Well, hidden among the 143 satellites SpaceX launched were 10 new kinds of Starlink satellites equipped with laser communication systems. Have a look:
These are what will enable the global backhaul network. Here’s why…
Without these nodes, one Starlink satellite can only communicate with another by transmitting down to a base station on Earth. From there, it routes the data transmission to a location where it can connect with another satellite at a different location in space. Obviously, this process takes time and causes latency in the communications.
These new Starlink satellites, referred to as nodes, will be able to route communications between satellites in space without the need to beam messages down to Earth first.
And since space is a vacuum, it is free of any interference. That means the communications can travel at the speed of light. There’s essentially no latency at all.
What we have here is the beginning of a true world wide web of satellite communications blanketing the Earth. I believe that’s been the goal this entire time.
With this successful launch, SpaceX now has more than 1,000 Starlink satellites in orbit. The company’s short-term goal is to get this number up to 12,000. From there, SpaceX may put as many as 40,000 Starlink satellites in space. It’s still early, but SpaceX is launching at a remarkable pace.
Robots will soon care for the sick and elderly…
We’ll wrap up today with a big announcement from Hanson Robotics. This is the company behind artificial intelligence (AI)-enabled robot Sophia.
Some readers may be familiar with Sophia. Since being unveiled in 2016, she has starred in an episode of the TV show Silicon Valley and has even interviewed famous actor Will Smith.
Sophia the Robot
Source: Hanson Robotics
Hanson Robotics just announced that Sophia has some friends on the way. The company will begin mass producing robot models, including Sophia, in the first half of this year.
The goal? “To keep people safe.”
Hanson Robotics envisions these robots – specifically, Sophia and a new model called Grace – being used to help care for the sick and the elderly. It also believes they could eventually be used in other areas such as retail and airlines.
Right now, they will mainly provide company in a time when many elderly people are isolated due to the COVID-19 pandemic.
Because they are equipped with AI and natural language processing, these robots can hold conversations with people. This can provide a therapy of sorts for people who just need to talk to someone throughout the day.
Given its stated goal of keeping people safe, Hanson Robotics must believe that its robots will help improve mental health and keep suicides down.
And I think there is a huge market for this.
Somewhat surprisingly, professional robots generated $11.2 billion in sales between 2018 and 2019. And with the rise of social distancing and isolation due to COVID-19, there’s no doubt the market size has grown tremendously over the past year. Surveys show that 40% of Americans are now struggling with at least one mental health or drug-related problem.
Hanson Robotics may be putting out the right product at the right time. The company expects to sell thousands of its robots every year. This trend may be larger than we think.
I’m keeping a close eye on the acceleration of the use of robotics for not just automation, but also for home and therapeutic applications. As we discussed earlier this month, the home robotics space is clearly on the rise.
Editor, The Bleeding Edge
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