Tesla Motors Inc (TSLA), Kinder Morgan Inc (KMI) & Why Being Wrong Could Be Your Ruin

3. Being right doesn’t guarantee success

Let’s consider David Einhorn’s battle with Allied Capital. In 2002, Einhorn publicly pointed out accounting irregularities with the company. Einhorn had a strong case and the bully pulpit. Allied Capital’s stock took an initial dip after he shared his thesis. But the stock proved resilient, rising over the the next few years. Along the way, there were numerous tribulations for Einhorn. Instead of investigating Allied Capital, the SEC investigated Einhorn. Allegedly, Allied Capital stole Einhorn’s phone records. His wife lost her job at Barron’s. Einhorn eventually wrote an entire book on Allied Capital. By 2007, Einhorn was vindicated — the SEC found fault with Allied Capital’s business practices. Its stock fell below his short price, but the profits for his fund were small, especially relative to the time, effort, and aggravation involved.

Of course, Einhorn is a famous hedge fund manager who publicly shared his case, thus inciting a battle with the company. As an individual short-seller, you won’t experience all the problems he had. But, it can still be hard. In January, I wrote a critical article about ParkerVision, Inc. (NASDAQ:PRKR). It’s a small, Jacksonville, Fla.-based company that has virtually no business operations. It’s been in business for 20 years without ever generating a profit. To keep itself afloat, it regularly raises equity from new investors, thus diluting existing investors. The primary beneficiaries of this non-business are its CEO, Jeffrey Parker, and his cronies in management. Even as the business loses money and shareholder value is destroyed, they keep getting paid. At present, the company’s primary reason to exist, aside from lining the pockets of management, is to litigate patent claims against Qualcomm. In my opinion, the company’s claims are largely hype, and its only chance to win a claim is legal incompetence (or favoritism). In August, I reiterated the case against the company, pointing out its continued cash burn. In all, there’s a very solid case against this company. But that hasn’t stopped the stock from running up. Year to date, the stock is up 65%. In the end, it’s proof that as a short-seller you’re subject to the whims of the market. Even the worst, most questionable stock might stay flat or even increase, in spite of common sense and a rational thesis.

4. The costs are very high

Short-selling is expensive. It depends on your broker and the stock, but there can be borrowing fees. If you use shorts to increase your gross investments, then you’ll pay interest for using margin. Also, as a short-seller, you’re responsible for paying the dividends associated with any stock you borrow. That can be expensive.

Last week, a research firm called Hedgeye suggested that investors short the shares of Kinder Morgan Inc (NYSE:KMI) and Kinder Morgan Energy Partners LP (NYSE:KMP). In short, Hedgeye analyst Kevin Kaiser alleged that both companies were a “house of cards” that under-maintained their assets and manipulated their financial results. His recommendation is to actively short both companies without any specific catalyst that will cause the stocks to fall. Aside from the fact that his accusations are complete hogwash, this is a foolish suggestion. Those two companies pay respective dividends of 4.5% and 6.6%. In other words, in addition to borrowing fees, margin costs, and trading commissions, you’ll need to pay 4.5% and 6.6% of your investment annually out of you account to maintain the position.