David Einhorn (Trades, Portfolio) is the founder and president of Greenlight Capital, a hedge fund with $2.5 billion in assets under management. He has made headlines in recent months with his short positions on companies like Tesla (TSLA, Financial) and Netflix (NFLX, Financial), both of which he believes are overvalued and are due to deliver shareholders a painful lesson in market exuberance. He has made money by both buying undervalued stocks and shorting bubbles. These are the key tenets of his investment philosophy.
Diversification
Like any good investor, Einhorn recognises that even his very best stock ideas have no guarantee of working out. Any given company can have any number of hidden risks that you, as an investor (particularly a small investor) do not have knowledge of. This is why diversification is so important - not because your analysis might be bad, but because even the best analysis in the world might not be enough to come to the correct conclusion when faced with the unknown.
Even though Einhorn likes to run a concentrated portfolio - General Motors (GM) makes up more than 16% of Greenlight’s total portfolio - he still understands the need to diversify. His advice is to have a risk management system, and to have limits to how much of a losing position you can afford to hold.
Minimise leverage
Many notable value investors try to avoid leverage. In particular, Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) have advised retail investors against using borrowed money to buy stocks. Leverage magnifies your losses just as much as it does your gains. Einhorn’s Greenlight Capital also stays away from leverage. For him, the risk of having a loan called in by your creditors is just one more investment risk to deal with. When you already have to contend with market risks and the idiosyncratic risks of individual stocks, why take on even more?
Critical thinking
During a talk at the Oxford Union back in 2017, Einhorn was asked to name what he considers to be the number one reason for Greenlight’s success. This is what he said:
“If I had to pick one, it’s critical thinking skills. It’s the ability to look at a situation and see it for what it is - which isn’t necessarily what is presented to you and when something makes sense, to figure out what makes sense, and when something doesn’t make sense, to question it, to challenge it, to look at it in a different way - and to often come to the opposite conclusion”.
Einhorn believes that this has enabled Greenlight to foster a culture of openness and self-criticism. Ray Dalio (Trades, Portfolio) has referred to a concept which he calls "radical truth," which is the idea that all ideas should be open to critique. In your own investing, encourage your peers to tear your investment theses to shreds - you may be surprised to see how much this improves them!
Disclosure: The author owns no stocks mentioned.
Read more here:
- Joel Greenblatt: Is There Still an Edge to Be Found in the Market?
- The Role of Emotion in Investing
- Joel Greenblatt on His Biggest Mistake
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
