First, that despite all logic to the contrary, if you had followed Warren Buffett’s investments in public companies from 1980 to 2006, once the trades were announced you still would have had real, significant returns. Approximately 6% returns (pg.13) The authors postulate that there was overconfidence by other traders as the root cause.

Second, more interesting to me is that Mr. Buy and Hold forever’s average holding time of an investment during this time was only one year (pg.10) with only 20% of the stocks being held more than two years. While nearly a third (30%) were sold in less than six months. This seems a case of do as I say and not as I do. I have often said that if you want to make money like Buffet you need to invest like Buffett did in the days of his investment partnerships. These funds were more like hedge funds and were more Graham oriented in style than Buffett has become. They also involved more buying and selling. I know this is not fashionable for value investors, but it worked for Buffett when his returns were often 50% a year. A small investor’s competitive advantage over large investors is that he or she can put money in less liquid investments without moving the needle very much.

Third, Buffett does run a relatively concentrated or focused portfolio. His average holdings in the 1980′s was 22, 12 in the 1990′s and 33 beyo0nd 2000 (pg.11)

Fourth, the study says that, “it appears that Buffett avoids firms with high asset growth that under-perform the market and invests in large firms with low book-to-market ratios and large accounting accruals, characteristics generally associated with low returns.”

I think the normal response for most value investors to the shorting question is “No.” But is that really true? And if this question is not true then the title question becomes more important to answer in a value investing context. Whitney Tilson of T2 partners and co-founder of the Value Investing Congress uses shorting as a part of his investment tool set. I don’t think anyone would call Tilson a “speculator,” which is the usual label associated with shorting. He uses the value investing techniques of examining the financial statements of companies and setting a value on the company. He currently is shorting a basket of homebuilders. And in his latest letter to investors he discusses his best short position, recently, which is Inter Oil (IOC). The excellent blog Valuehuntr has also taken a short position in the same company. Valuehuntr’s position is based on the premise that IOC may be engaging in fraudulent behavior. If this is true then this could be another company that drops to the floor.  Both Tilson and Valuehuntr’s logic and analysis seem sound. But I am still not going to short. Why?

Because I am risk averse. There are aspects of shorting that concern me. First, what is shorting? The idea of shorting is that sometimes it makes sense to take a negative position in a company. Shorting is where you “borrow” the shares of a company from someone else, say your broker, and then you sell the shares in the market.  The proceeds are deposited to your account. A profit is made when you buy back the same shares at a lower price and return the shares to the entity that lent them to you.

So what are the risks of Short selling?

The first is the potential for extreme losses. The ordinary potential loss when buying the stock of a company is the amount you invested. If you invest $1000 buying 100 shares of XYZ company.  All you can lose is $1000 plus commissions. But when you short a company and the stock price goes up you can keep losing money until you exit the position. It is often referred to as the potential for unlimited losses. It isn’t of course. No company’s stock price continues to rise forever. But the losses can be extreme.

A risk related to this is the risk of margin call. That is when the stock price rises you will be asked to post additional collateral in your account to cover the loses. I never want to be a position for someone else to decide when it is a good time for me to invest more capital into a position. If the price move up is swift you may not have any choice.

The counter argument, of course, is that you can use stops to help prevent just such a scenario. This is true, sort of, but my experience is that stops work poorly in volatile markets like now. If there is an extreme price movement your stop may be triggered but the next price up could we much worse price for you than you would like.  Moreover, the stop could be triggered and then the share price retreats, but you have already covered your short and thus you have baked in your loss.

It is clear to me that short selling can play a role in a value investing strategy. After all no one expects every company to always go up. But is shorting the only way? Or are there better alternatives? In the next installment of this I will explore the world of options. While I have not yet fully developed a shorting strategy using options I will discuss some of the possibilities in the second part of this article.

I took an unexpected hiatus from writing my blog. If you emailed me in the last few weeks, my apologies for not responding, I will strive to resume my prompt reponses in the future.

First, the most important reason I have been absent: my wife gave birth to our first son on May 16th. The time that I would usually spend on my blog has been in part spent with my new child.

The second reason is that after six seasons “Lost” has finally come to an end. As some of you may know, I have had the great pleasure of working as a Producer on the show. The second reason I dropped off the face of the earth is that I was completing the finale. Until now, I did not feel it was appropriate to discuss what exactly my day job was, now that it is over I feel that I can. This will not be a forum for discussing “Lost,” it remains a place to explore investment ideas.

And we are living in interesting times for investors.

But for people like me, it brought a smile to my face.

Uh, What?

In the sea of red, I thought, wow, there are almost certainly some stocks that have dipped into the value terroritory again. Many small caps got punished way out of proportion to the overall market. That is one of the great things about investing in small cap stocks. Opportunity number 1 is the pool of possible investments just went up.

If you are scared about the long term prospect of a stock you own, don’t blame the market, perhaps you shouldn’t own it. Opportunity number 2 is re-evaluating your portfolio. We all make mistakes. The question is whether you would buy more of stocks that you own at a lower price. If not, again, it is a time to reexamine the choices you have made. Perhaps you have been too hasty in making stock selections. I have certainly done that.  I am reviewing all my positions. If I don’t think they are still great opportunities, and if they are below the price I purchased them, then I probably made a mistake. If I confirm that I like the investment, perhaps I should add to my position.

Market Drops are opportunities for finding value and reevaluating your positions. If you look you will find value. Happy hunting.

I will be posting irregularly for the next couple of weeks. I am working on the series finale  of a television series of I have been working on for years. Think of it as tax season for an accountant. I am slammed, but still looking for value.

Small Investor Portfolio

Current Positions

DUCK up 27.2%

IFON down 13.2 %

Closed Positions

ORXE up 31.% including commissions.

This is all well and good, but I did not completely deploy capital so where is this portfolio really?

Started with $2000. Value of account before additions and other amounts, including commissions paid is $2204.88 for a total of 10.2% gain in approximately one month. Also made one monthly deposit of $200. Also received Choice Trade promo offer of $50 as discussed in my posts about choosing an online broker. Total account value today is $2454.88

80-20 Portfolio

Closed positions

HAST up 57%

Opened account with $5000 Account is worth $5285.75 including commissions paid but not additions. That is 5.7% up on the portfolio for the month. I have added my monthly amount of  $300, so the actual current total is  $5585.75. There are no current positions in this account.

The S & P 500 gain in the same period is 3.06% although given my investments perhaps a better comparison is the Russell Small Cap index was about 6.9% A one month result and the subsequent comparison to an index is really very silly, since it is too early to compare anything to anything else.

I first learned about this concept when reading Nassim Taleb’s book The Black Swan. He called confirmation bias “naive empiricism”. He said, “You take past instances that corroborate your theories and you treat them as evidence.” Further he writes, “I am saying that a series of corroborative facts is not necessarily evidence. Seeing white swans does not confirm the nonexistence of black swans.” He cites a study by P.C. Wason. In the experiment subjects were given a three number sequence of 2,4,6 and asked what rule would generate this sequence. “Their method of guessing was to produce other three-number sequences, to which the experimenter would respond “yes” or “no” depending on whether the new sequences were consistent with the rule. Once confident with their answers, the subjects would formulate the rule.” The problem is that most people will say something like 8,10,12. And the answer would be yes. After a couple of confirming examples you would announce that the rule was add 2 to the number before it, in succession. But the correct answer is actually any ascending numbers. I failed this example when I read it one of James Montier’s writings when he posed the question to the reader. I was reading about the problem and still fell for it.

How to prevent confirmation bias in our approach to investing?  Taleb directs us back to Karl Popper and his concept of “falsification.” We should attempt to prove false the ideas we are using. Again Taleb, “We can get closer to the truth by negative instances, not by verification!“  Popper, Taleb says leads the way out of our darkness, he “…introduced the mechanism of conjectures and refutations, which works as follows: you formulate a (bold) conjecture and you start looking for the observation that would prove you wrong. This is the alternative to our search for confirmatory instances. If you think the task is easy, you will be disappointed—few humans have a natural ability to do this.” In the Wason study, the way to figure out the proper rule would have been to submit numbers that declined, alternated, etc. To prove what the actual rule was by ruling out as many of the opposites as possible. It is only by figuring out what doesn’t work that you figure out what does.

The interesting idea to ponder is that if you are naturally a contrarian, like I am, you will be instinctively drawn to contrarian investing ideas, like value investing.  These ideas make more sense to me, than say momentum investing. But, am I really just looking for investing ideas that confirm my pre-existing biases? Perhaps.

It may also be why, even though I consider myself a value investor, I have not felt compelled to be bound by some rules that seem to appear in the blogsphere. Investing is ultimately a path, not a destination, this is just another pot hole to avoid.

Today as the market dropped over 2%, HAST dropped over 17% to exactly the price sold at last week. Regret comes and goes. I have moved on to other  investment prospects.

Also, remember that this profit in HAST is  only a 5.7% increase in the 80-20 portfolio. Now obviously if I could make 5% a month, every month I would be quite, pleased. But I don’t have those kind of expectations.

Disclosure: I have no current positions in HAST.

I do not recommend purchasing this stock anymore, since it has appreciated so much in the past two weeks. In fact it has come very close to my selling point. I did not get my order filled or I would have sold it today.

Here is why I purchased this stock

1. Piotroski F-score of 9 (out of a possible 9)

2. Net Current Asset Value of approximately $4.54/share (so, price was just under Net Current Asset Value.

3. Negative Asset Growth.

4. Altman Z score for non-Manufacturing companies 3.77

5. Price to Book .59

Strategy: Put in a limit order when it crosses 50% gain again, which it did earlier today, but my sell order did not get filled.

Disclosure: As of this posting I own 110 shares of HAST. I do not recommending buying them right now.