Really forensic accounting. Fundamental short selling has its roots in detecting abnormalities in operations or financials or both. Short sellers create a hedge (insurance policies) that pays polite premiums.
Interestingly, both common myth knocking short selling are not accurate. It is neither true that you can lose an infinite amount of money (since you can invest in hedge funds a limited partner and risk only the capital you have contributed) and that you can only get 100% return (since gains from the initial investment can be re-invested, increasing your leverage on the trade without deploy any new cash capital).
Enron was essentially a leveraged hedge fund with a pipeline. They would trade anything.
Exposed the largest security frauds in history: Baldwin Piano (selling obscure insurance contracts). Then, Enron -- where mark to model accounting (favourable regulation for energy company).
Odd accounting + only earning 6% RoI in a market that was booming. People were also paying 6x NAV for this relatively slow growth. They had merchant banking arm that would mark their gains on the income line, but losses were held as discontinued assets and buried.
Warning signals: Combo of insider selling + executive departures.
Bankers when to congress during the crisis and asked for relaxed account rules (allow us to mark to market) and ban on short selling.
Willful blindness.
To Chanos this was a major tell, what he teachers his students at Yale -- willful blindness -- that bankers were in DEEP trouble since all they wanted to do was hide the facts and blame vilify short sellers.
At the best of times, buy backs should be avoided. There are many reasons for this, but fundamentally the math is NOT in favour of CEOs encouraging buybacks.
Given the average pre-tax return on capital in corporate America is mid-to-high teens versus stocks which typically return ~6% per year, buybacks implicitly purport outperformance of broader market relative to their own company!
They are signaling investors that no internal project(s) exists that would yield returns in excess of the stock market.
Gains marked thru operating income line, losses held as discontinued asset, for a year, then disregarded as extrordiary event. Put losers below operating income line, by depreciating them.
Odd footnotes: Enron executives set up entities, where Sr Exec of the Company is trading with them. They were essentially counterparties to themselves?
McKinsey came up with the idea (accounting gimmick) to do the above, and sell to themselves.
So hide, obfuscate, and distract. Not acknowledge their profligate lending.
Willful blindness in financial history class. Case based of investment fraud (back to 1690's). See Yale class taught by Chanos, book "Blame the Shorts" where throughout history anyone who profits from anothers loss is made a villain, despite the reality of investing = zero sum game.
Virtually all major frauds have been uncovered by journalists, short sellers. Not auditors or regulators.
Buybacks
"every CEO thinks their stock is undervalued"
Corp USA pre tax return on capital mid-high teams. Equity market roughly 1/2 that.
Thus CEO + massive buy backs = happy to earn market return (or 1/2 that of a good firm). OR rate of return on new capital project is less than that which you can get in the equity market.
So they are buying the market instead of investing in their operations.
Dell spent more money on buybacks then they have earned in their entire lifetime.
CEOs are terrible market timers. Applies to M&A. Corp activity is not a leading indicator, its a laggard.
M&A -- replacing capex (capital spending or R&D) -- this should be deducted from FCF. Capitalizing their R&D is a bad play, esp in big tech.
Revenues are bolstered by big aqcistions that done with debt. R&D not expensed, but capitalized, and thus earnings are overstated. (Depreciate their acquisitions, rather then expensive R&D).
Ability to Herg Greenberg 'cookie-jar' the earning through acquisitions.
Everything we saw that was bad in China in 2010, is x2 as bad now. 60 billion sq ft. now 2x that amount. More debt, less growth. Idea that farmers moving into the city is flawed since the
50% investment to GDP is the model. If it takes 2 years to finish a project, 1/4 of GDP rolls off the books every year since that investment is transient.
Bulk of the GDP from investment means that the economy is being driven by something which cannot be sustained. It needs to be replaced with something organic... like consumption.
Net exports in China are 12% of GDP, now ~0. Thus China as mega-exporter is not accurate. The story a giant government funded property boom.
Chinese banking system is built on quicksand. Bad loans all over the place, not likely that non-performing loans are < 1% as stated.
Nature of finance as large % of corporate profits is somewhat self-defeating. Bailouts prohibited market clearing during the GFC of 2008-09.
Blocking creative destruction leads to a monstrous rube goldberg machine that is the modern banking system. Auto companies were good models of capitalism during this period.
Industry got bankruptcy, finance gets bailouts.