Consolidated Trash: A Look at AOL & Huffington Post

Recently, I reminded readers of a very lucrative (and what I felt was a very obvious) long-short equity strategy I discussed that would have yielded huge returns to those who opted to take on this risky maneuver.  

I normally don’t recommend that everyday investors take short positions because it’s extremely risk for many reasons. Most non-professional investors fail to recognize the risks involved with shorting securities because taking a short position is just a mouse click away if you have an online brokerage account. That in itself is an entirely different issue that needs to be addressed by the SEC.

Unless you have a good deal of relevant investment experience, you’re not likely to full appreciate the risks involved with shorting. Some unwary investors have learned the hard way after taking a short position, only to watch helplessly as the stock is halted during the trading session prior to the release of a major announcement. While such events can swing either way, more often than not, such an announcement is likely to go against you if you’re short.

There are times when I feel very confident about a company’s bleak future. In the past, I have made the bold move to publish a short recommendation in a book. As discussed recently, I made this call when presenting my analysis of Blockbuster in the Wall Street investment Bible. I added that a nice example of an effective long-short strategy would be to take a long position in Netflix and a short position in Blockbuster.

As many of you recall, I also made this call for Fannie, Freddie, the banks and homebuilders in Cashing in on the Real Estate Bubble, released in early 2007.

In this book my main strategy for making money from the real estate bubble was to short real estate-related securities. I made specific mention of those securities I felt most likely to collapse and provided guidance as to the timing. I even included a brief tutorial for those who were not experienced shorting stocks.

First on this list were Fannie, Freddie, Accredited Lender, Novastar, and Fremont General. Next were the banks and homebuilders. I also discussed that General Electric and General Motors were likely to get hit really bad.

The downside associated with putting these calls into a book is that I had no way to change my mind if I turned out to be wrong. So if things didn’t turn out as I anticipated, I might have looked silly. But that wouldn’t have been the first time a person made a poor investment call in a book. In fact, I challenge you to see if you can find a book that has ever specifically instructed readers to short a stock. You are unlikely to find a single case because shorting is a short-term strategy that often reverses.

The point I want to make is that all investment strategies must always be managed. Even if someone has overwhelming evidence to indicate a company is destined for demise, the fact is that no one has a crystal ball. Things can and often do change over time. Thus, if you ever plan to take a short position you must hedge your position. And you must manage the position throughout its duration.

One way to hedge a short position is to purchase call contracts. But you cannot expect to receive a full hedge against the position unless you select in-the-money calls (whereby the strike price is below the price of the underlying stock at the time you short it) to account for slippage, frictional costs, exit premiums and other less obvious costs. Many investors don’t like to pay the added costs involved with hedging, but I can assure you it is well worth the price.

Here I want to show you another example of a more recent long-short position. Note that I am not recommending investors take this long-short at this point. There are man better opportunities out there. I merely wanted to point it out to show the irony.

As many are aware, a few days ago AOL announced its purchase of Huffington Post for around $315 million. Immediately after the announcement the Internet was buzzing with the news. First , let’s take a brief look at Huffington Post.