Collection: Warren Buffett - #241 'Short Selling'



[Transcript]

AUDIENCE MEMBER 00:00

Hi, I’m Dave Staples from Hanover, New Hampshire and I’ve got two questions for you.


First, I’d like to hear your thoughts on selling securities short and what your experience has been recently and over the course of your career.


The second question I’d like to ask is how you go about building a position in a security you’ve identified.


Using USG as a recent example, I believe you bought most of your shares at between 14 and $15 a share. But certainly, you must’ve thought it was a reasonable investment at 18 or 19.


Why was 14 and 15 the magic number? And now that it’s dropped to around 12, do you continue to build your position? How do you decide what your ultimate position is going to be?


WARREN BUFFETT 00:43

Well, we can’t talk about any specific security, so — our buying techniques depend very much on the kind of security we’re dealing in. Sometimes, it’s a security that might take many, many months to acquire. And other times, you can do it very quickly. And sometimes, it may pay to pay up. And other times, it doesn’t.


And the truth is, you never know exactly what the right technique is to use as you’re doing it, but you just use your best judgment based on past purchases. But we can’t discuss any specific one.


Short selling, it’s an interesting item to study because it’s, I mean, it’s ruined a lot of people. It is the sort of thing that you can go broke doing.


Bob Wilson, there’re famous stories about him and Resorts International. He didn’t go broke doing it. In fact, he’s done very well subsequently.


But being short something where your loss is unlimited is quite different than being long something that you’ve already paid for.


And it’s tempting. You see way more stocks that are dramatically overvalued in your career than you will see stocks that are dramatically undervalued.


I mean there — it’s the nature of securities markets to occasionally promote various things to the sky, so that securities will frequently sell for 5 or 10 times what they’re worth, and they will very, very seldom sell for 20 percent or 10 percent of what they’re worth.


So, therefore, you see these much greater discrepancies between price and value on the overvaluation side. So you might think it’s easier to make money on short selling. And all I can say is, it hasn’t been for me. I don’t think it’s been for Charlie.


It is a very, very tough business because of the fact that you face unlimited losses, and because of the fact that people that have overvalued stocks — very overvalued stocks — are frequently on some scale between promoter and crook. And that’s why they get there. And once there —


And they also know how to use that very valuation to bootstrap value into the business, because if you have a stock that’s selling at 100 that’s worth 10, obviously it’s to your interest to go out and issue a whole lot of shares. And if you do that, when you get all through, the value can be 50.


In fact, there’s a lot of chain letter-type stock promotions that are sort of based on the implicit assumption that the management will keep doing that.


And if they do it once and build it to 50 by issuing a lot of shares at 100 when it’s worth 10, now the value is 50 and people say, “Well, these guys are so good at that. Let’s pay 200 for it or 300,” and then they could do it again and so on.


It’s not usually that — quite that clear in their minds. But that’s the basic principle underlying a lot of stock promotions. And if you get caught up in one of those that is successful, you know, you can run out of money before the promoter runs out of ideas.


In the end, they almost always work. I mean, I would say that, of the things that we have felt like shorting over the years, the batting average is very high in terms of eventual — that they would work out very well eventually if you held them through.


But it is very painful and it’s — in my experience, it was a whole lot easier to make money on the long side.


I had one situation, actually, an arbitrage situation when I was in — well, it was when I moved to New York in 1954, so it would’ve been about June or July of 1954 — that involved a surefire-type transaction, an arbitrage transaction that had to work.


But there was a technical wrinkle in it and I was short something. And I felt like a — for a short period of time — I felt like Finova was feeling last fall. I mean, it was very unpleasant.


It — you can’t make — in my view, you can’t make really big money doing it because you can’t expose yourself to the loss that would be there if you did do it on a big scale.


And Charlie, how about you?


CHARLIE MUNGER 05:04

Well, Ben Franklin said, “If you want to be miserable, you know, during Easter or something like that,” he says, “borrow a lot of money to be repaid at Lent,” or something to that effect.


And similarly, being short something, which keeps going up because somebody is promoting it in a half-crooked way, and you keep losing, and they call on you for more margin — it just isn’t worth it to have that much irritation in your life.


It isn’t that hard to make money somewhere else with less irritation.


WARREN BUFFETT 05:42

It would never work on a Berkshire scale anyway. I mean, you could never do it for the kind of money that would be necessary to do it with in order to have a real effect on Berkshire’s overall value. So it’s not something we think about.


It’s interesting though. I mean, I’ve got a copy of The New York Times from the day of the Northern Pacific Corner. And that was a case where two opposing business titans each owned over 50 percent of the Northern Pacific Company —the Northern Pacific Railroad.


And when two people each own over 50 percent of something, you know, it’s going to be interesting. And — (Laughter) — Northern Pacific, on that day, went from 170 to a thousand. And it was selling for cash, because you had to actually have the certificates that day, rather than the normal settlement date.


And on the front page of The New York Times — which, incidentally, sold for a penny in those days. It’s had a little more inflation than Coca-Cola — front page of The New York Times, right next to the story about it, it told about a brewer in Newark, New Jersey who had gotten a margin call that day because of this.


And he jumped into a vat of hot beer and died. And that’s really never appealed to me as, you know, the ending of a financial career. (Laughter)


And who knows? You know, when they had a corner in Piggly Wiggly, they had a corner in Auburn Motors in the 1920s. I mean, there were corners. That was part of the game back when it was played in kind of a footloose manner. And it did not pay to be short.


Actually, during that period — you might find it interesting — in the current issue of The New Yorker, maybe one issue ago, the one that has the interesting story about Ted Turner, there’s also a story about Hetty Green.


And Hetty Green was one of the original incorporators of Hathaway Manufacturing, half of our Berkshire Hathaway operation, back in the 1880s. And Hetty Green was just piling up money. She was the richest woman in the — maybe in the world. Certainly in the United States. Maybe some queen was richer abroad.


But Hetty Green just made it by the slow, old-fashioned way. I doubt if Hetty was ever short anything.


So as a spiritual descendent of Hetty Green, we’re going to stay away from shorts at Berkshire.


OK, area 6.


Hetty, incidentally — this story, it’s a very interesting story. As I read the story, it’s almost conclusively clear to me that she forged a will to try and collect some significant money from, I believe, her aunt.


And it was a very, very famous trial back in whenever it was, 1860 or ’70. And they found against Hetty when it got all through, but she still managed to become the richest woman in the country. Area 6.


(Source: https://buffett.cnbc.com/2001-berkshire-hathaway-annual-meeting/)

~ Please visit the site above for full video of Berkshire Hathaway Annual Meeting.

 

[YAPSS Takeaway]

Yeah it's very painful, just look at Melvin Capital and GME.