Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

Caesars Entertainment Corp (CZR), Nokia Corporation (ADR) (NOK): Dangers of Shorting Stocks on Display This Year

“The markets can stay irrational longer than you can stay solvent.”
— John Maynard Keynes

On the surface, shorting stocks isn’t a tough concept to understand. You’re simply betting the stock will go down instead of up. All you have to do is look for companies that are performing poorly, and you’ve got a guaranteed winner, right?

The challenge of shorting stocks is that all sorts of things can get in the way of short-sellers, many of which don’t make a lot of sense. The irrational market is much as Keynes identified, and this year irrationality appears to be extraordinarily high in the market.

Caesars Entertainment Corp (NASDAQ:CZR)When terrible stocks go up
The few short trades I’ve made have been in companies that I think are really terrible fundamentally. This approach reduces the risk of being on the wrong side of a growth stock the market never seems to value logically, but even betting against bad companies has its risks.

Take Caesars Entertainment Corp (NASDAQ:CZR) as a prime example in 2013. The company has lost $1.4 billion in the past year, revenue is declining, and it’s drowning in debt, yet the stock is up 215% this year. In this case, investors have been suckered in by the promise of a spinoff including the company’s online gaming operations, which themselves don’t have any real revenue yet. I don’t think the sum of the parts make any sense, but the market says differently.

CZR Total Return Price Chart

CZR Total Return Price data by YCharts

Nokia Corporation (ADR) (NYSE:NOK) is a similar story. The company lost $5 billion last year and has no real momentum against smartphone giants Apple Inc. (NASDAQ:AAPL) and Google Inc (NASDAQ:GOOG). But a sudden offer by Microsoft Corporation (NASDAQ:MSFT) to buy its handset unit boosted the stock, killing short-sellers in the process. Is Nokia suddenly a good company? No, but that doesn’t mean the stock can’t go up.

Even betting against bad companies who perform terribly financially can result in massive losses for short-sellers.

Leave logic at the door
The market can be even more maddening for those trying to short stocks they think are wildly overvalued. Tesla Motors Inc (NASDAQ:TSLA) is worth just under a third of what Ford Motor Company (NYSE:F) is worth, or $1 million per car it produces each year, yet the market doesn’t bat an eye at what the stock is trading for. Plus, using GAAP, the company hasn’t turned a profit yet. Trying to envision how Tesla can live up to its current valuation will leave even the best investing minds scratching their heads.

Stern School of Business professor Aswath Damondaran, a well-respected mind on valuation and finance, Tweeted last week that even if “Tesla Motors Inc (NASDAQ:TSLA) grows to have Audi-like revenues ($67 b) & Porsche-like margins (12.5%), I can’t get past $70/sh.” Take a look at his full argument here and see just how fast Tesla would have to grow to live up to expectations.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.