Warren Buffett & Charlie Munger: Short Selling

In the unpredictable world of stock trading, many strategies aim to maximize profits and minimize risks. One of the most popular is short selling stocks. Warren Buffett and Charlie Munger are two famous people known for their wise advice and successful investment careers. This article examines their insightful views on one such tactic—betting against the market or profiting from the decline of a stock by selling it short, a practice that is often as attractive as it is controversial. Drawing from their experience and unique wisdom, they provide enlightening insights into the complexities of the practice, potential risks, and misconceptions surrounding it. Their lessons offer valuable guidance for new entrepreneurs and seasoned investors alike. Learn how these investment titans navigate the challenging and volatile terrain of the stock market.

Warren Buffett and Charlie Munger on Short Selling

Below is a transcript from the 2001 Berkshire Hathaway annual shareholder meeting. Warren Buffett and Charlie Munger explain why they don’t like shorting stocks.[1]

The question was asked, “Hi, I’m Dave Staples from Hanover, New Hampshire, and I have two questions for you. First, I’d like to hear your thoughts on short selling securities and what your experience has been recently and over the course of your career. The second question I want to ask is how do you create a position in a security that you know. Using USG as a recent example, I assume you bought most of your short shares between 14 and 15 a share, but surely, you thought it was a reasonable investment at 18 or 19. Why are 14 and 15 the magic number? And now that it’s down to about 12, are you continuing to build your position? How do you decide what your final position will be?”

Warren Buffett answered, “Well, we can’t talk about any specific security, so our buying methods depend a lot on the type of security we’re dealing with. Sometimes, a security can take many, many months to acquire and other times you can do it quickly. And sometimes, it can pay to pay, and other times it doesn’t. And it’s true that you never know what the right technique is to use when you do it, but you just use your best judgment.” judge based on past purchases. But we can’t discuss anything specific.”

“Short selling is an interesting thing to study because it hurts a lot of people. It’s the kind of thing you can do. Bob Wilson, there are famous stories about him and Resorts International. He didn’t fail to do it, in fact, he did very well after that, but in short, something where your loss is unlimited, it’s different than going long, something you’ve already paid for.

“It’s tempting. You will see more overvalued stocks in your career than you will see undervalued stocks. It is the nature of the securities markets to sometimes promote different things in the sky. Therefore, securities often sell for five or ten times their value, and very rarely sell for 20 or 10 percent of their value. Therefore, you see more differences between price and value in the overview segment. “

“So you’d think it would be easier to make money short selling. And all I can say is it’s not for me. I don’t think it’s for Charlie. It is a very difficult business because of the fact that you face unlimited losses and because of the fact that people who overvalue stocks, stocks that are overvalued, are always in some measure between promoter and crook. And that’s why they got there. “

“And once they’re there, they also know how to use that valuation to bootstrap the value of the business. Because if you have a stock that sells for 100, that’s 10, it’s obviously in your interest to go out and issue more shares. And if you do that when you’re done with everything, the value will be 50.”

“In fact, there are a lot of chain-letter-type stock promotions that are based on the implicit assumption that management will continue to do that. And if they do it once and build up to 50 by issuing more shares of 100 when it was worth 10, now the value is 50. And people say, ‘Well, these guys are very good at that, let’s pay 200, 400, or 300, and then they can do it again and others.

“It’s not usually clear in their minds, but that’s the basic principle underlying a lot of stock promotions. And if you get caught in one of the successful ones, you’ll run out of money before the originator runs out. In the end, they almost always work. I mean, I’d say that on the things that we’ve felt lacking over the years, the batting average is very high in terms of the results in the end. They’re very good in the end if you stop them.”

“But it was very painful, and it was my experience that it was easier to make money on the high side. I had a situation, in fact, an arbitrage situation, when I moved to New York in 1954. There was a surefire type of transaction and arbitrage transaction that had to work, but there was a technical wrinkle in it, and I was a short thing, and I felt that, in a short time, I failed. It was not good.”

“You can’t, I think, make a lot of money doing it because you can’t expose yourself to the loss that there would be if you did it on a large scale. And Charlie, how are you?”

Charlie Munger added, “Well, Ben Franklin said, ‘If you want to be miserable, borrow a lot of money to pay for Lent,’ or something like that. And similarly, the short thing that keeps going up because somebody’s promoting it in a half crooked way, and you keep losing, and they’re calling you for more margin; you shouldn’t have that much resentment in your life. It’s not that hard to find money elsewhere in life less irritation.”

Buffett added, “It just doesn’t work on a Berkshire scale. You can’t do it for the kind of money it takes to do it to have a real impact on the overall value of Berkshire. So, it’s not something we think about. It’s interesting, though; I mean, I have a copy of the New York Times from the day of the Northern Pacific corner, and it was a case where two rival entities each owned more than 50 percent of the Northern Pacific Railroad. And if the two people each have more than 50 things, you know it’s interesting.

“The Northern Pacific that day went from 170 to a thousand, and it sold for cash because you had to have certificates that day rather than the normal settlement date. And on the front page of the New York Times, which coincidentally sold for a penny in those days, right next to the story about it, it told about a brewer in Newark, New Jersey, who got a margin call that day because of it and he jumped into a vat of hot beer and died . That doesn’t really appeal to me as the end of a career in finance.”

“And who knows, when they had a Piggly Wiggly corner, there was an Auburn Motors corner in the 1920s. There were corners that were part of the game back then when it was played in a kind of footloose way. And it doesn’t pay to be brief really in that era you might find interesting, in today’s issue of the New Yorker, maybe an issue ago, the one that has an interesting story about Ted Turner, there’s also a story about of Hedy Green. Hedy Green was one of the original incorporators of Hathaway Manufacturing, half of our Berkshire Hathaway operation, back in the 1880s. And Hedy Green, she just made money; she’s the richest woman in the United States, maybe in the world. Maybe a queen is richer overseas. Hedy did it the slow, old-fashioned way; I doubt if Hedy lacked anything. So, as a spiritual descendant of Hedy Green , we stay away from Berkshire shorts.

Key Takeaways

• Short selling is a complex and high-risk strategy that involves the potential for unlimited losses.
• Market anomalies often lead to more overvalued stocks than undervalued ones, making it tempting for traders to engage in short selling.
• However, successful short selling is challenging due to unpredictable market forces and the manipulative tactics of promoters and fraudsters.
• While short selling can result in large profits in the short term, it is often more rewarding and less stressful to invest in undervalued stocks in the long haul.
• Making money through short selling is not good for significant financial growth because of the associated risks and the inability to do it on a large scale.
• Short selling often brings more frustration and anger than it’s worth, especially when dealing with fraudulently promoted stocks.
• Despite its attractive nature, short selling is not a viable strategy for large investment entities such as Berkshire Hathaway.

Conclusion

In their detailed analysis of short selling, Warren Buffett and Charlie Munger highlight the dangers and complexities that overshadow its potential profits. They argue that the highly unpredictable stock market, coupled with the potential for dishonest stock promotions, can lead to catastrophic losses. Although large short-term gains can be tempting, their experiences suggest that a long-term, value-driven approach is the most profitable, sustainable, and least stressful investment strategy. It becomes clear that the difficulty and risks of short selling, especially on a large scale, outweigh the potential rewards. Therefore, aspiring and experienced investors alike would do well to follow this advice from two of the most successful investors of our time.