'It was almost a decade after I first started trading that I realized the importance of short selling," says Shah.
Sharad Shah has been a stock market trader since the mid-80s. An otherwise low-profile player, Shah shot into limelight in early 2009 when he short sold the futures of real estate firm Hubtown (then Ackruti City). Shah had to contend with a rival market operator, who apparently had been funded by people wanting to protect the stock price.
The futures, which were trading at Rs 617 in the second week of January, surged to a record high of Rs 2148 by mid-March, and dramatically collapsed to a low of Rs 700 barely a week later as Shah and the bull operator slugged it out. Even as the drama was playing out, the NSE dropped the stock from the futures & options list from the next settlement cycle, without giving any clear reason.
Two years later in 2011, the Reliance-ADAG group complained to the Intelligence Bureau that Sharad Shah was at the head of a traders’ cartel hammering the prices of infrastructure companies for personal gains, by spreading rumours about the financial health of the companies.
ADAG is not the only corporate group that Shah has had a run-in with. A self-professed bear trader, Shah has been under attack from many companies—particularly midcaps--whose stocks he short sells. There have been reports of Shah having to face physical violence at times. But that has not changed his style of trading.
“Long term short selling is my investment strategy,” he said in a free-wheeling chat with CNBCTV18.com.
Excerpts from the discussion:
The stock market has been rising despite the damage to the economy from COVID. What is driving prices higher?
Until last month, it was (buying by) retail investors and promoters playing their stocks. Since the last week or so, it seems to be only promoters. Retail (investor) is slowly moving out.
Why is retail exiting the market?
Most retail investors had got into the market to kill time because they had nothing else to do during the lockdown. Now that restrictions are easing, people are getting back to their main work.
How do you make this connection?
By looking at the volume of shares traded, turnover value and number of trades. When retail investors are active, the average size of the trade is small and there is more number of trades. Over the last few days, the average size is getting bigger, and the number of trades, smaller.
How do you see the market in the near term?
The market is hugely overpriced at this point. Even if you buy good stocks, you may make 10-15 per cent gains at best. Corporate earnings are not going get better anytime soon. People seem to forget that even before COVID hit, the numbers, by and large, were pretty pathetic.
Which are the sectors you are particularly bearish on?
Financial services. Barring a handful, banking stocks have rarely made money for investors over the long term. And that is not the case just in India, it is a global trend. You can count the number of banks which have made money for investors over the last 15 years on your fingertips. HDFC Bank has been one such name. Maybe two or three others.
The banking sector will be hit hard by the COVID pandemic and its impact on the economy. Even in the best of times, I have always found the banking business model a bit strange.
When the bank lends Rs 5 lakh, the borrower will repay on time and the bank will make money. But if the amount is Rs 50 crore, it is not a given that the borrower will repay on time.
How do you identify stocks to short sell?
The stock has to be part of the futures and options list. But I won’t just short sell because the stock has made a lifetime high or that the market thinks it is overvalued. I look at many indicators, starting with the balance sheet. That gives me an idea about the company’s fundamentals. I look at the price movement and the open interest (outstanding positions) in the futures. Very high open interest is a red flag for me.
If it is a large-cap stock, high open interest is not unusual. But if it is midcap and the open interest is high, most likely the high open interest has to do with some operator—usually on behalf of the company—using the futures position as a financing tool to prop up the stock price.
Could you explain that?
There are arbitragers who provide such finance. They will buy shares from you and then sell an equivalent quantity of futures at a slightly higher price. The difference is the interest cost. The operator will get the full amount for the shares sold, and while taking a long position in futures, needs to pay only the margin money. The remaining money is used to buy more shares from the market and ramp up the stock price.
In the case of DHFL futures, the open interest at one point was more than that of Maruti and Larsen put together. Why should there be so much interest in DHFL?
Any other indicators that you keep an eye out for?
Yes. I happen to know a few hawala dealers who create fake invoices for companies, which helps them show artificial expenses and (artificial) revenues. I ask them about companies which do it too often. That tells me something about the company’s numbers which the profit & loss statement won’t.
Many companies have complained to the regulator about you hammering their stock price through unfair tactics. Does that affect you, as a trader as well as personally?
Companies have complained to the regulator, intelligence bureau, even to the police. The more unscrupulous ones have complained to politicians and the underworld. I have been through all that. I have had a few FIRs (first information reports) against my name, filed by companies for short selling their stock.
Strangely none of these companies ever tried to convince me that I was wrong about my view of their stock. By blaming me for the problems with their stocks, they were only exposing their weakness.
Once you identify stocks to short sell, what is a typical time frame for your trade?
Long term short selling is my investment strategy. Once I identify the stocks, I could stay short on its futures for as long as 4-5 years. Because even when things are wrong with the company, it could take that long for the market to recognize the problem. In the meantime, the management and others close to them will be able to support the stock for long periods of time. You need be ready with money to take losses when the price moves against you. I lost a lot of money in Opto Circuit, though my call was eventually proved right.
Are the rules in India loaded against short sellers?
I don’t think so.
But whenever the market falls, the regulatory restrictions usually focus on short selling.
True. But then you need to protect the market. When markets are stable, everybody gets a fair shot at making money…even short sellers. If markets keep falling one way, short-sellers may profit for a while, but eventually, everyone loses money.
How did you decide on stock market trading as an occupation?
My father had a small portfolio of shares. While studying I tried my hand at investing and had some success. After studies, I tried my hand at a few jobs before deciding to take up trading as a profession. Losing a good sum around the time of the Gulf War in 1990 taught me that trading alone could not help you make a fortune. That is when I decided to build a portfolio of blue-chip shares.
It is said that short selling is a difficult technique because, by nature, most human beings are optimistic. When did you start taking bearish bets?
It was almost a decade after I first started trading that I realized the importance of short selling. That is when markets had started getting volatile, and you could not always profit by going long.
You just mentioned the need for long term portfolio. What are you bullish on?
Industrials (industrial goods sector). Particularly the MNC ones. The returns given by stocks like Siemens and SKF Bearings over the last 15-18 years are mind-boggling. There are many such stocks. You may not get the same kind of returns here on. So I am focusing on the MNC names with a market capitalization of sub-2000 crore. If I am alive after ten years, those stocks will give me handsome returns.
I focus on the product and the management, not so much on the financials initially. A few quarters of losses don’t bother me much if the company has a good product and competent management. When I decided to invest in Siemens back in 2003, it had reported a few quarters of losses. But that did not change my decision. My only regret is that I cashed out too soon.
I am also bullish on defence and companies that do business with the railways. Both segments will do very well as the economy recovers.
How can retail investors profit from the stock market?
They would be better off not buying stocks directly. Very few of them understand what they are buying; most of them just focus on the price. You need a lot of patience. After all, good stocks don’t go up every day. Retail investors should stick to index funds, gilt funds and gold funds.
First Published: IST