Berkshire Hathaway Inc (BRK.B)

[bar1080]

Buffett/Munger on Shorting:

What are your thoughts on short selling?

It's an interesting item to study. It's ruined a lot of people. You can go broke doing it.

You'll see way more stocks that are dramatically overvalued than dramatically undervalued. It's common for promoters to cause a stock to become valued at 5-10 times its true value, but rare to find a stock trading at 10-20% of its true value. So you might think short selling is easy, but it's not. Often stocks are overvalued because there is a promoter or a crook behind it. They can often bootstrap into value by using the shares of their overvalued stock. For example, it it's worth $10 and is trading at $100, they might be able to build value to $50. Then, Wall Street says, "Hey! Look at all that value creation!" and the game goes on. [As a short seller,] you could run out of money before the promoter runs out of ideas."

Everything we've ever thought about shorting worked out eventually, but it's very painful. It's a whole lot easier to make money on the long side. You can't make big money shorting because the risk of big losses means you can't make big bets.

[Munger: "Being short and seeing a promoter take the stock up is very irritating. It's not worth it to have that much irritation in your life."]

We would never short anyway because we're too big.

•Source: BRK Annual Meeting 2001 Tilson Notes
•URL: http://www.thebuffett.com
•Time: April 2001

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[Charlie Munger: "It's dangerous to short stocks."]

"Charlie and I have agreed on around 100 stocks over the years that we thought were shorts or promotions. Had we acted on them, we might have lost all of our money, every though we were right just about every time. A bubble plays on human nature. Nobody knows when it's going to pop, or how high it will go before it pops.

A.W. Jones, which had a long-short model, developed the best-known hedge fund in the late 1950s and early 1960s. They were market neutral, but didn't stick with it. Something went wrong with A.W. Jones. A very high percentage of its spin-off funds bit the dust. There were suicides and people lost their fortunes and had to drive cabs.

Ben Graham didn't find shorting particularly successful. Quite a high percentage of his paired investments worked, but he lost a lot on the few he lost on.

I had a harrowing experience shorting a stock in 1954. I wouldn't have been wrong over 10 years, but I was very wrong after 10 weeks, which was the relevant period. My net worth was evaporating.

Shorting is just tough. You must bet small. You can't short the whole company. It takes just one to kill you. As it rises, it consumes more and more money.

•Source: BRK Annual Meeting 2002 Tilson Notes
•URL: http://www.thebuffett.com
•Time: April 2002

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There’s nothing evil about short selling. There are people on the short side who have done things to make some stocks go down – some of which is appropriate and some of which is inappropriate. People do that on the long side as well, so I have no ax to grind with short sellers. We have no problem with anyone shorting Berkshire stock. There’s nothing I’d like more than to be paid to lend my stock to shorts.

I do think it’s a very tough way to make a living, both financially and psychologically. If you buy something at $20, you can lose $20. If you short at $20, you’re loss can be infinite.

As you know, we have a friend who’s been outspoken on naked shorting [referring to Overstock CEO Patrick Byrne, who used to be President and CEO of Berkshire subsidiary Fechheimer Brothers]. I don’t have a great problem with it. If anyone wants to do that with Berkshire, more power to ‘em.

Companies with a large short interest very often have been revealed as frauds or semi- frauds – not the one my friend runs. Over the years, I’ve probably had 100 ideas of things to short and I would have eventually been right [on almost all of them]. But [because it’s so hard to get the timing right,] I likely wouldn’t have made much money and there would have been a huge opportunity cost. Someone who’s running a fraud is probably very good at it and can keep it going a long time. I would never put money with a short fund – not because I have any problem with it ethically, but because I question if they could make money over time.

[Charlie Munger: It would be one of the most irritating experiences in the world to do a lot of work to uncover a fraud and then watch it go from X to 3X and watch the crooks happily partying with your money while you’re meeting margin calls. Why would you want to go within hailing distance of that? [Laughter]]

•Source: BRK Annual Meeting 2006 Tilson Notes
•URL: http://www.thebuffett.com
•Time: 2006

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I’ve never been in a position to ask a broker from whom I’ve bought to deliver the shares and not had it happen.

I don’t see the problem of people shorting stocks, assuming they’re not manipulating the market. I would welcome people wanting to short Berkshire. In fact, I’d lend them stock and earn extra income. They’re a certain future buyer.

If anyone wants to naked short Berkshire, they can do it until the cows come home. In fact, we’ll hold a special meeting for them. [Laughter]

The shorts generally have a tougher time of it in this world. More people are bullish on stocks. It’s a tough way to make a living. It’s very easy to spot a phony stock or a heavily promoted stock, but it’s hard to say when it will turn. If it’s trading at five times its intrinsic value, there’s no reason it can’t trade at ten times.

I don’t see shorts as any great threat to the world. If a lot of people want to short your stock, they have to pay you [for the borrow]. We did this with USG. One large brokerage firm approached us [about lending out our stock] and we were happy to do this. We charged them a lot. We even forced them to hold it for a certain period of time so we could continue to earn money on the borrow.

Munger: There’s tremendous slop in the clearance process. It’s not good for a civilization. It’s like having slop in the management of your nuclear power plants.

Buffett: If I buy 1,000 shares of GM and ask my broker to deliver it and he doesn’t, what’s the situation?

Munger: If you’re a private customer, you have to wait a while. There’s a lot of slop in derivative trading.

Buffett: But can’t I take my broker to court after three weeks?

Munger: I don’t think that there’s any court that can give you a stock certificate just because you want it.

•Source: BRK Annual Meeting 2007 Tilson Notes
•URL: http://www.thebuffett.com
•Time: 2007

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[Q - What do you think of short sellers being investigated for being publicly bearish and short selling companies? Is short selling healthy? Is a healthy discussion between bulls and bears healthy for the markets?]

Buffett: There is nothing wrong with people who are positive or negative speaking out as long as they are responsible for what they say. You can do things on the long or short side that are unethical or illegal. Anytime you attack conventional wisdom though, you will get a lot of negative feedback. When he and Charlie criticized the EMH (Efficient Market Hypothesis), it was so widely accepted people didn’t like their comments. In general he has no problem with short selling.

Munger: For the most part we are criticizing the wrong people (the short sellers). The people the criticisms should go to are the accountants who allowed the bad accounting should be held in the dock. The accountants let this happen, and they get very little criticism, and that is a mistake.

•Source: BRK Annual Meeting 2010 Claremon Notes
•URL: http://www.thebuffett.com
•Time: 2010
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