Why it is tough to short stocks

Buffett: 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.

[Charilie 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

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Buffett: “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.”

Buffett: “We would never short anyway because we’re too big.”

Source: Notes from the 2001 Berkshire Hathaway Annual Meeting

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[Munger: “It’s dangerous to short stocks.”]

Buffett: “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

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BECKY: I’d like to get your take on them. First of all, on short sellers, he [Charlie Munger] said, ‘We don’t like trading agony for money.’

BUFFETT: The reason he said that is because a stock, when you short it, can theoretically go to infinity. When you buy a stock at 10, you can only lose 10 points. When you short a stock at 10, it can go to 100 or 200. And occasionally you’ll get into a situation on a short where you may know eventually it’s going to turn out to be worth nothing, or very close to it, or it’s a fraud, but what it can do in between can be very, very unpleasant. We like to sleep well, and you can’t sleep well if you’re short a lot of stocks.

Source: CNBC Interview, 4 May 2012

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