I always like looking at research and experiments, both academic and decidedly un-academic, for ideas. One that I recently stumbled upon when I was looking into the updated Piotroski F-Score research piece from AlphaArchitect was an individual’s attempt to generate a basket of stocks to short using a combination of the Piotroski F-Score, the Ohlson O-Score, and the Altman Z-Score. It made sense: he was screening for companies that were doing poorly and had a high risk of bankruptcy.
This idea wasn’t rigorously backtested, but it was timely as the article, along with the short basket of stocks identified, was published on February 13th, 2020. Ie, right before the pandemic devastated stock markets all around the world.
So how did the 10 stocks that should have gone bankrupt do through the pandemic and into November? The chart below shows the results:
Assuming an equal weight, the return for this basket of stocks was 37 percent.
That’s a positive 37 percent return.
And these were companies that were supposed to be super-stressed with one foot already in the mass grave of corporate America. Yet one stock provided a large enough return to skew the short & hold basket into being a better performing portfolio than $SPY or $QQQ.
If you’re wondering what the two big winners were involved with:
Workhorse Group ($WKHS) is an electric vehicle manufacturer with barely any revenue, massive losses, and an incredible amount of debt on its balance sheet. In spite of that, the stock price shot up as high as 800 percent between February 13 and September (after dropping ~50 percent through March).
cbdMD ($YCBD) uses proprietary artificial intelligence neural networks to trade bitcoin and other cryptocurrencies… I’m just kidding – it manufactures and sells CBD products in the United States in the form of tinctures, gummies, and even some for pets. Their stock price increased as much as 250 percent through August after dropping ~50 percent in March.
If you short, you have to be a trader
I recently saw that David Einhorn announced he was shorting a basket of tech darlings even though he got burned back in 2016 when he tried the same thing based on valuation alone. There’s probably more going on under the hood of his fund than was reported, but there are an incredible number of instances where “expensive” stocks got more expensive (Amazon and Tesla anyone?). And while the market appears to be cooperating with him right now, it’s not something I’d want to try given the results of the “bad” companies identified above.
However, even if you took the 10 stocks from the screen above, it would have still been possible to generate positive returns from the shorts if you had used a simple trend filter and a profit target. The simple trend filter would have taken $WKHS’s ~454 precent return off the table and the rest would have either hit a profit target or been closed out for more modest gains or losses, all while protecting your overall portfolio’s drawdown during the economic crisis caused by the pandemic.
Being a trader isn’t for everyone – and there’s nothing wrong with that. But I’ve never come across any research, academic or otherwise, that’s ever shown you can short a basket of stocks based on fundamentals alone and make a profit.