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The Quindell PLC Story Shows Why Short Selling Is Good!

In places where Quindell (LSE: QPP) bulls gather, there have been fresh calls of late for short-selling to be banned in the UK, with fingers of blame for the fallout squarely pointed at bears. But that’s misguided, and I want to tell you why:

What was it worth?

Let’s start with a guess at a true valuation of Quindell. For a long time we had to rely on the company’s own accounting, though there were many cautious voices casting doubt on its policy of including large figures for accruals in its annual earnings statements. Since the PwC investigation, we now know that the policy was over-aggressive, and that Slater & Gordon discounted it in working out a realistic valuation for its acquisition of some of Quindell’s insurance assets.

A fair assessment of Quindell shares, now that so much of the uncertainty has been shaken out, suggests that a price of 126p per share is probably about right. I did think the price would drop to zero myself, and I’m happy to admit I was wrong. And the downwards pressure put on by short sellers did lead some people to sell out at much lower prices earlier in the year. Does that mean short selling should be stopped? Absolutely not!

Whoa!

You see, the same market pressures that turned Quindell around from a low of 24p in December and saved further downside losses are also the same market forces that halted the bubble-like rise to over 600p per share in early 2014 — and reduced the pain of the inevitable crash.

Had Gotham City Research not published its opinions, had short-sellers not piled in, and had close scrutiny not been brought to bear on Quindell’s actual profit and cash position, the share price would almost inevitably have soared higher — and more people would have lost more money when the true financial situation finally came to light.

Did short selling hurt some people when the price was on the way down? Yes, for sure. But did short selling help those who would earlier have naively jumped on the bandwagon and lost a lot of money? Absolutely, yes.

Free market

The truth is that short selling is a vital part of a free market, and significantly adds to the efficiency of capital allocation. Those who think a share is too cheap should be entirely free to take up long positions — but at the same time, those who think it’s too expensive should be free to go short.

I’d argue that such freedom brought about the best result for Quindell that we could realistically have hoped for, resulting in a significantly better allocation of its assets than would have been likely had short selling been banned.

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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.