Being a successful hedge fund manager requires not only being able to recognize which assets have the potential to increase in value—it also means being able to recognize which ones are fundamentally overvalued.
Sahm Adrangi and his team at Kerrisdale Capital were able to successfully identify yet another opportunity to short a stock and turn a major profit. The ability of the firm to correctly identify overvalued assets is one of the many reasons they have been able to outperform the S&P 500 Index for several quarters in a row.
The stock that the team was able to successfully short belonged to Proteostasis—a biotech company that is based out of Cambridge, Massachusetts. The company experienced a growth in stock value after some recent work was completed related to cystic fibrosis. However, the team at Kerrisdale Capital thought that at least a significant portion of this growth was inauthentic.
Kerrisdale was able to recognize that much of Proteostasis’ jump in stock value came after releasing data related to a recent study. The data, at face value, suggested that a new drug was performing 5.2% better than before. But Sahm Adrangi and his team didn’t want to just look at the face of the data—they wanted to look deeper.
Upon a closer examination, the team realized that, due to the incredibly small placebo group used in the study, the data was short of the standards that ought to be applied to the biotech community. Because the insufficient nature of this study was particularly easy to recognize, it seemed inevitable that the growth in stock would inevitably be at least partially reversed. An opportunity to capitalize off of a short sale had inevitably emerged.
Armed with a firm criticism of the data in hand, the team at Kerrisdale Capital decided to act quickly. The study was the reason for most of Proteostasis’ value and, according to Kerrisdale, without data supporting the effectiveness of their product, they could likely anticipate over a 70% decrease in value.
Initially, the stock took a steep 13% plummet. After the market had the opportunity to respond to Kerrisdale’s shorting strategy, the stock then reached a 20% drop in value. This has enabled Adrangi and his team to earn a considerable sum of money once they decide to complete their short sale.
As more market analysts continue to recognize the somewhat dubious nature of Proteostasis’ research methodology, it seems the company’s stock value will likely continue to deteriorate. Naturally, in an industry that is as heavily dependent on a commitment to scientific principles as the biotech industry is, the objective value of the company is something that will need to be supported by hard evidence.
This entire event is yet another example of Kerrisdale Capital doing the research that is necessary to find the objective value of a stock. Had they overlooked the details of the recently released report, Kerrisdale would have missed out on a major opportunity to capitalize. The lesson that can clearly be learned here is that, when it comes to intelligent hedge fund management, details certainly matter.
You can find the biotech short seller on Twitter or check out the full Proteostasis report for yourself.