Why investors should celebrate short sellers; Gabriel Grego nails Cassava Sciences; A preview of Warren Buffett's will; Greetings from Trani, Italy

1) You can thank short sellers for exposing all sorts of misdeeds...

In my past two e-mails (you can read Monday's here and Tuesday's here), I've written about a wide range of scoundrels and shenanigans in the financial world – some of which is exposed by short sellers going public with their concerns.

So I was especially interested in this Bloomberg essay from yesterday: People Dislike Activist Short Selling. It's by one of my favorite columnists, Matt Levine.

In it, Levine notes (correctly) that many people think there's something untoward – if not illegal – about doing research on a stock, concluding that it's overvalued (perhaps because of fraud), going public, and profiting if the stock then declines. As he writes:

There is some apparent intuition that it is market manipulation: You are betting that a stock will fall, and then you are making it fall (by publishing your report), and that seems somehow like cheating.

In practice, most people who don't like it will complain that the report is inaccurate – it is more clearly market manipulation if the report is wrong – but I think that some of this really is driven by suspicion of the whole business model. Even if the report is entirely accurate and based on public information, something about the model strikes people as icky.

Levine then goes on to present a slightly different approach, in which the short seller shares his research with a large hedge fund, which then takes a short position, and then they share the profit if the stock declines. Many people really don't like this, as Levine (again, correctly) notes:

I think people find it even ickier. In particular, there is something about the collusion between the short researcher and the hedge fund that rubs people the wrong way.

Surely it is unfair for the hedge fund to trade on the researcher's report before it is published. The report is nonpublic information (it hasn't been published yet), and it is material (if it causes the stock to go down), so isn't it insider trading for the hedge fund to trade on it?

I understand why many people feel this way... but they're absolutely wrong.

They should be celebrating both types of activist short selling.

As I've argued in hundreds of my e-mails over the years, the stock market is filled with hype, fads, frauds, and plain old overvaluation. This leads to many wildly overvalued stocks – and huge losses for average investors duped into investing in them.

There are huge forces at work pushing stocks higher than they should be, led by company executives, who stand to make millions (if not billions) of dollars if their stocks go up a lot, even briefly and unsustainably.

They, in turn, are almost always cheered on by Wall Street "analysts" (I use that term loosely, as most simply parrot what companies tell them) and the media.

So what's protecting investors? Not much.

Regulators can't do anything about hype and overvaluation, just fraud – and are so outmanned and outgunned that they can only address a fraction of it (and even when they do, it's usually long after the stock has crashed).

So short sellers – especially those courageous enough to go public with their work – are a critical factor that can protect investors, as hundreds of examples and lots of academic research show.

Yes, sometimes short sellers are wrong... But long investors are frequently wrong as well. And the market is generally very smart. I've seen stocks go up after an activist short seller publishes a poorly researched report.

And, yes, there are cases where a short seller publishes a knowingly false report in the hopes of driving a stock down to make a quick buck, but this is exceedingly rare – mostly because it's illegal and short sellers don't want to be investigated, much less go to jail.

The U.S. Justice Department has been investigating trading abuses by dozens of short sellers for at least three years (Investopedia has more details here). And, as I predicted long ago, it has been nothing but a misguided and counterproductive wild goose chase.

But what about Levine's second example, in which there appears to be "collusion between the short researcher and the hedge fund"?

This is ridiculous.

Every large hedge fund has numerous analysts who pitch ideas, some of which the portfolio manager acts on, and then at the end of the year, the analysts get bonuses in part based on whether their ideas made money for the firm.

So what's the difference if a hedge fund outsources a short idea to an external analyst?

2) Here's the latest example of the important role activist short sellers play...

In Monday's e-mail, I gave a shout-out to my friend Gabriel Grego of Quintessential Capital Management, writing:

Gabriel has an extraordinary track record of uncovering fraud all over the world. So I e-mailed him last week to ask what he's most bearish on right now. As he replied:

We are still bearish (and short) Cassava Sciences (SAVA) given our extreme skepticism on the ongoing clinical trials. The stock is trading around $18, 85% below its peak and 55% below our initial short call. But, in our opinion, that's $18 too expensive...

I've written many times warning about Cassava (archive here), starting on November 3, 2021, just after Gabriel released his initial short report.

I think he makes a compelling case, so avoid this stock at all costs!

Sure enough, SAVA shares have already crashed to less than $12 in the wake of an 8-K filing with the U.S. Securities and Exchange Commission in which Gabriel writes that the company "essentially admitted to virtually all our allegations!" Here's a recent Wall Street Journal article about it: Cassava Sciences Adviser Indicted on Fraud Charges.

3) Fellow Warren Buffett junkies will be interested in this WSJ story about how Buffett has changed how his fortune (currently at $130 billion) will be distributed after he passes: Warren Buffett Gives Us a Preview of His Will. I was glad to see this, as I admire what his children are doing philanthropically. Excerpt:

In an interview with The Wall Street Journal, Buffett – the chairman and chief executive of Berkshire Hathaway – said that after his death nearly all of his remaining wealth will go to a new charitable trust overseen by his daughter and two sons.

The legendary investor also made clear his giving to the Bill & Melinda Gates Foundation, to which he has donated billions, will come to an end.

"The Gates Foundation has no money coming after my death," Buffett said.

The Omaha, Neb., billionaire has already given away more than half his shares of Berkshire, the company he took control of in 1965 and built into a powerhouse. After the latest round of charitable contributions unveiled Friday morning, Buffett owns nearly $130 billion of the company's stock.

4) Greetings from Trani, Italy, where my friend Ciccio Azzollini and I will be hosting our Value Investing Seminar for the 20th time tomorrow and Friday!

Fifty attendees from all over the world are flying in today and will be sharing their latest thinking about the markets and their favorite stocks. I'll be sharing the highlights in upcoming e-mails, so stay tuned!

Here's a picture of Ciccio and me (and his friend Davide) with my wife and our three daughters (then aged 2, 5, and 8) who joined me at the first seminar:

They long ago stopped accompanying me because they have summer camp, jobs, etc., but to celebrate the 20th anniversary, they're back! We flew in Monday night and toured the beautiful city of Matera yesterday. Here's a picture of us (I posted more pictures on Facebook here):

Best regards,

Whitney

P.S. Our offices will be closed tomorrow and Friday in observance of Independence Day, so look for my next daily e-mail on Monday, July 8, after the Weekly Recap. Enjoy the holiday!

P.P.S. I welcome your feedback – send me an e-mail by clicking here.