Short selling research firms, such as Bonitas Research and Muddy Waters, are making themselves heard in international capital markets. Some are even going as far as flagging out their intentions well in advance. For example, Bonitas Research, following on from its recent attack on blue-chip stock Hengan International, recently revealed to Bloomberg News that it will launch a new attack against two more Chinese stocks – at least one of which is listed in Hong Kong – in January 2019. It also flagged out plans to publish at least one investigative research report each month.
Investigative research typically goes hand-in-hand with short-selling as its release usually causes a company’s stock price to plunge, allowing the short seller to benefit from its timing. The research usually questions a company's intentions and integrity, while perhaps also alleging fraudulent conduct.
It is often difficult for investors to assess whether the accusations are true, an exaggeration or at worst, misleading. If the financials of the company in question are opaque or has a management team that remains silent and poorly communicates with investors, it can be an easy target. For these reasons, many companies lack the ability to make effective and quick clarifications against cleverly worded accusations.
How then can investors avoid holding shares in companies that are vulnerable to short seller attacks?
Three points should be considered:
1. Shareholder base
Does the company have a solid base of institutional investors? This is a good starting point for defending against stock volatility.
2. Share buy-back and regular dividend policy
Share buy-backs and regular cash dividends are helpful ingredients for creating a solid share price environment.
3. Investor engagement
The market trusts companies that are open, transparent and well-governed, compared to those that are silent, defensive and inaccessible. In other words, is a company willing to communicate with investors? A company that is able to articulate its corporate strategy is far better equipped to defend itself against the aggressive accusations of short-sellers. Its shareholders can more easily obtain useful information in order to assess the credibility of the accusations.
Sometimes, short-sellers do uncover legitimate problems and shortcomings. For investors, in addition to financial indicators, it is also important to observe the integrity, choice of accounting policy, and whether the management is willing to communicate with investors in order to invest wisely.