The Perfect Short Sale – Revisited
By Jeff Clark
August 21, 2008
It was my pick for the "best idea of the year."
Last November, I told everyone at a conference put on by my publisher (Stansberry & Associates Investment Research) that my favorite trade for 2008 was to short Salesforce.com (CRM). CRM provides Internet-based customer relationship management software. The stock was a balloon looking for a pin, and it was easy to argue for its demise.
At the time, CRM was trading at $56.73 per share. That put its valuation at over 350 times earnings, 17 times book value, and 10 times sales. Sure, its high growth rate justified a premium valuation. But no stock deserves to be trading at 350 times earnings. I was convinced CRM would fall, and I called it "the perfect short sale."
And for nine months, I've been wrong.
Despite a ravaging bear market that trimmed 20% off the S&P 500, cut the financial and homebuilding sectors by 65%, split most technology stocks in half, and slapped around every other high-flying darling on Wall Street, CRM remained unscathed. In fact, it rallied.
As of yesterday, CRM was trading at $66 – about 16% above where I said to short it. But I don't mind. Sometimes it takes a while for the market to recognize the brilliance of my ideas.
Besides, rather than shorting shares of the stock itself, my recommendation was to use options to create a sort of "synthetic" short position.
Synthetic positions act like the underlying stocks, but they can often be structured to reduce risk to an infinitesimal level. The CRM synthetic position I recommended at the conference was designed to profit if the stock dropped, stayed the same, or even rallied a bit.
In fact, the only way we can lose money on this position is if CRM closes above $72.60 per share on option-expiration day in January 2009. That's 30% above the already inflated price when we entered the trade.
After yesterday's earnings announcement, it doesn't look like we'll have to worry about taking a loss on this trade anymore. In fact, it should be wildly profitable.
CRM announced earnings of $0.08 per share for the most recent quarter. That's right in line with analysts' expectations. But the shares are going to gap sharply lower this morning. I suppose when you're trading over 300 times earnings, merely meeting expectations isn't quite good enough.
CRM will likely open below $60 per share, which will put us in the black on our synthetic short sale. But this decline is only the beginning. The stock needs to lose another $15-$20 to bring it back into the realm of realistic valuations.
My bet is it will happen by January.
Best regards and good trading,
Jeff Clark
