Short Seller Kerrisdale Capital Shares Its Secrets for Success in the Markets
Editor’s note: This article was updated on May 24 to correct Kerrisdale’s assets under management figure.
Over the past decade, Kerrisdale Capital has consistently generated positive returns in the form of hundreds of millions of dollars. Sahm Adrangi, Kerrisdale’s CIO, founded the hedge fund in 2009 with less than $1 million in initial capital. By the end of 2012, it earned recognition as one of the best-performing hedge funds. Today, the fund manages over $550 million.
Along the way to impressive returns, Kerrisdale managed to grow a noteworthy social media following as well. Kerrisdale is active on its Twitter account, which boasts over 69,000 followers.
“We want to engage our audience and show personality in our research and our firm,” Adrangi said in an exclusive interview with InvestorPlace.
Kerrisdale is notorious for its high-quality and brazen short reports. What makes the hedge fund stand out, however, is that it is willing to share its secrets with the public.
Short-Selling With a Touch of Flair
In 2014, Kerrisdale rented out a Manhattan auditorium and gave a three-hour-long presentation to investors on why Globalstar’s (NYSEMKT:GSAT) valuation at the time was irrational. Pershing Square’s Bill Ackman, one of the most highly regarded names in the hedge fund industry, often used the same auditorium to share his investment ideas. Kerrisdale even purchased the rights to factsaboutglobalstar.com to support its claim.
“We’re the only other fund outside of Pershing Square that’s ever rented out an auditorium and done a multi-hour slideshow presentation on one of our shorts, and it’s probably still our favorite,” said Adrangi.
Kerrisdale doesn’t always rent out fancy auditoriums to share its research. Oftentimes, the hedge fund uses Twitter and Twitter Spaces as a way to engage with everyday investors. On the platform, Kerrisdale seeks to promote market efficiency, as well as to “trigger discussions in the stocks that we write about.”
“The dialogue that goes on Twitter is helpful for everyone, and I think it makes everyone more educated. That’s good for the markets,” Adrangi said.
Unfortunately, retail investors aren’t only engaging with well-researched investment ideas on social media. With the prevalence of online investing communities, interest in stocks has risen to an all-time high in recent years. Along with the increased interest in stocks comes an increase in misleading information. As a result, Adrangi believes that “there’s just a lot of garbage in the markets.”
— Kerrisdale Capital (@KerrisdaleCap) April 20, 2022
Adrangi’s latest short reports focus on names that are popular with retail investors, such as Digital World Acquisition (NASDAQ:DWAC) and Astra Space (NASDAQ:ASTR). In the two reports, he questions each company’s unrealistic forecasts. For example, Astra’s financial projections relied on 165 and 300 rocket launches for 2024 and 2025, respectively. At the time of publication, Astra had only successfully launched one rocket into orbit after six previous failures.
We're short $ASTR. Report at https://t.co/s3QiLOk7Zo. Facing a 91m share lockup expiry tmrw, $ASTR is 2021’s worst space SPAC: a $2b pre-rev launch co, announced at height of the bubble, bleeding cash trying to build hundreds of puny, unreliable rockets for a nonexistent mkt 1/7
— Kerrisdale Capital (@KerrisdaleCap) December 29, 2021
Kerrisdale has gained acclaim for shorting the stocks of companies that it believes are overvalued or are engaged in fraudulent or sketchy activities. Adrangi first broke into the mainstream investing world in 2010 when he successfully shorted several fraudulent Chinese companies.
Throughout the past decade, Kerrisdale hasn’t lost its touch for flair. Recently, the fund started adding “punny” subtitles to its reports to add a breath of humor. For example, in the Astra report, the subtitle reads “Headed for Dis-Astra.”
So, how exactly does Kerrisdale choose which stocks to short?
Kerrisdale Shares Its Research Process: Math Matters
Adrangi takes a very mathematical approach when researching companies. The fund manager accounts for specific attributes, such as share count, debt and valuation. A company that dilutes its share count and relies on debt extensively for capital may not make the best long-term investment.
For example, in Kerrisdale’s short report on Camber Energy (NYSEMKT:CEI), it estimated that Camber’s fully diluted market capitalization was almost three times greater than what the company reported due to its dilutive preferred stock and debt. Kerrisdale also stated that Camber’s share count had increased 50 million fold from early 2016 to July 2021. Share count dilution has the effect of decreasing a shareholder’s ownership of a company due to the issuance of new equity, which in turn can reduce the stock price.
We are short $CEI. Report avail at https://t.co/Tdwm1bSFni. This one has something for everyone: death-spiral financing, a fake CFO, delinquent filings, fired auditors 3 wks ago, insolvent energy assets & the saddest family of entrepreneurs in the cleantech vaporware space ☹️ 1/7
— Kerrisdale Capital (@KerrisdaleCap) October 5, 2021
Furthermore, Adrangi is an adamant supporter of using the discounted cash flow (DCF) model as the basis of valuing a company. The DCF model relies on discounting future cash flows back to the present value using the weighted average cost of capital (WACC). Interest rates are a major component of the model; a higher interest rate signifies a lower present value when all other factors are held constant.
“Investing in the stock market should be a lot more mathematical than anything else. Ultimately, these are entities that spit out cash flow and you’re paying a certain price for them, and it depends what those cash flows are. So, reducing every investment decision to a math equation, people will be better served if they do that than a whole lot of other things.”
When researching a new short idea, Adrangi also considers the track record of a company’s management and its business partners. Turning back to the Camber short report, Adrangi points out that Camber’s “only real asset” is a 73% stake in Viking Energy (OTCMKTS:VKIN), therefore, “Camber is effectively a bet on Viking.” Additionally, Viking also had a shady history that ultimately factored into Kerrisdale taking a short position against the company.
For yrs, CEO Doris ran Viking with an allegedly fake CFO. When SEC asked then-chairman Simeo if the CFO was made up, he pled the 5th. Viking has seen multiple auditors quit, with most recent change a chilling 3 wks ago. CEI’s filings aren’t current & delisting is a real risk 6/7
— Kerrisdale Capital (@KerrisdaleCap) October 5, 2021
Since 2012, Viking has rebranded several times and changed up its leadership, such as through bringing on James Doris as CEO to revamp the company. Doris did the exact opposite. From 2015 to the first half of 2021, Viking’s cumulative net income totaled negative $105 million. The company’s financial statements also warned of “substantial doubt regarding the Company’s ability to continue as a going concern.”
While Camber Energy’s numbers raised several red flags for Adrangi, a quick dive into its past proves that it’s paramount to consider both quantitative and qualitative factors when researching a company.
Macroeconomic factors, such as inflation, weigh into Kerrisdale’s research process as well.
How Kerrisdale Can Shine Despite a Poor Macro Backdrop
Adrangi thinks it’s reasonable that a recession will occur in the next year due to rising interest rates that may detrimentally affect the U.S. housing market. Higher interest rates also lower the value of future cash flows when discounted back to the present.
Adrangi isn’t sure how inflation will play out in the future, but he stated that at some point, inflation will ease and supply chain challenges will resolve. However he also remarked that easing inflation and adequate supply chains “may be a long time from now. Maybe four or five years from now.”
As a result, investors should prepare for the possibility of an extended, high-inflationary environment. Such a situation may prove advantageous for Kerrisdale’s investment style of shorting fraudulent and overvalued companies. Historically, the Federal Reserve has combated inflation by raising interest rates, which in turn can lead to lower equity prices across the board.
Still, even some of the most experienced hedge fund managers have been caught off guard by this year’s sharp decline in the market.
Everyone Makes Mistakes, Even the Experts
The hedge fund industry is a highly competitive landscape where even the most skilled managers are prone to mistakes.
Take Chase Coleman’s Tiger Global, for example. As of April 30, its flagship fund had declined by 44% year to date. The S&P 500 lost about 14% in the same time period.
Based on this year’s returns alone, you’d be surprised to hear that Coleman is regarded as one of the best hedge fund managers of all time. Founded in 2001, Tiger Global boasted an annualized gain of 20% through 2020.
“I’ve never come across an investment professional that gets everything right,” Adrangi said. “We all make mistakes. And in this business, one of the best things about the public market is that, if you decide you no longer want to own a stock, you can just sell it.”
In light of the market decline, though, Kerrisdale’s publicly disclosed short positions have been doing extremely well. Since releasing the short report on Astra Space on Dec. 29, ASTR stock has declined by over 60%. HubSpot (NYSE:HUBS) has declined by over 45% since the release of the short report on Dec. 22.
Kerrisdale’s recent success proves that in times of difficulty in the markets, it’s best to focus on the long term. “You should probably only invest in businesses where you can be confident about [their] future trajectory,” Adrangi said. “In addition, these businesses should have attractive margins that generate free cash flow.”
In the end, investing is a highly mathematical concept that requires diligent and constant research. When researching a company, an investor should try to look far out in the future and estimate whether or not that business will still be relevant. This is applicable for both long and short positions.
So, if you want to succeed like Kerrisdale, open your spreadsheets and get those DCF models running.
On the date of publication, Eddie Pan did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.