David Einhorn (Trades, Portfolio) is one of the world's most successful hedge fund managers and the founder of Greenlight Capital. In a rare interview at the Oxford Union in 2017, he discussed his keys for success in both business and life. I have created a short summary of this interview and combined it with my own research from his shareholder letters. Let’s dive in.
The future of value investing
Einhorn said, “Value investing over time has worked.” However, he did note the strategy does not work in all moments and markets. For example, in 2017, he was under pressure as many growth stock investments were doing well and value was getting destroyed.
At the time he said, “I believe this is a cyclical phenomenon” and it will “revert” over time. He was correct as in 2021-22, we experienced high inflation and a rising interest rate environment which hurt growth stocks and gave a boost to value.
Performance
Greenlight Capital returned a healthy 25.3% in 2022, beating the market as the S&P 500 was down around 18%. The firm has not had the best start to 2023, however, returning 1.3%, compared to 7.5% for the S&P 500 Index. While its long positions have gained 9.9%, its short positions lost 10.8%.
Be a contrarian
Contrarians by nature have an uncanny ability to extract the signal from the noise and are not afraid to go against the consensus. As mentioned previously, Einhorn has stuck with his value investing approach even through the bad times. The ability to resist external pressure to follow the herd and stay disciplined is a key success trait.
Poker and Investing
Einhorn is an avid poker player who believes the skills can be applied to investing. Both games involve having a limited set of information and then making a series of calculated bets.
In investing, the “information” can be quantitative in nature, such as revenue and earnings. IT can also be qualitative in nature, which includes assessing the brand, management, etc. Einhorn suggested “combining what you know” with what you think you can surmise and a “range of possible outcomes” appear.
In poker, you know your cards and you can see the cards on the table. But also there is uncertainty as there are cards in the deck that you do not know who has.
Investing internationally
The guru has a focus on investing in developed markets such as parts of Europe and the U.S. He is not a fan of investing “too far away” in places such as China and India. This is due to “local customs, local knowledge,” which is hard to assess. Einhorn stated this strategy in 2017 and thus he managed to swerve the recent slaughter we have seen in many Chinese stocks.
Shorting companies
Einhorn runs a long-short hedge fund, but he does not just short companies based on “overvaluation.” He is looking for overvaluation combined with some “deterioration” in fundamentals. He looks for businesses that are over “90% overvalued” and thus, it is obvious.
Dealing with risk
There are many “unknown unknowns” when investing. Einhorn handles this through portfolio construction. He is fairly diversified with approximately 47 stocks and runs his fund unlevered.
Setbacks are setups
The investor originally wanted to do a PhD in economics, but he was rejected from all the schools he applied for. This was actually a blessing in disguise as he then went on to startup Greenlight Capital in 1996. The moral of the story is that setbacks are stepping stones to success.
Most people only see the end result, or the tip of the iceberg, and often overlook all the prior rejections. As an analogy, J.K. Rowling, the author of the Harry Potter series, had her book rejected by 12 publishers before someone finally saw its potential.
The importance of critical thinking
Einhorn said he was in the debating society at university. He believes the ability to debate both sides of an argument is an immensely powerful skill since, when buying a stock, you have reasons to buy, but someone else has reasons to sell. The key trait to success is the ability to “think critically” when making an investment.
Management Culture
Greenlight's culture is based around “smart, nice people” who respect each other's time, no matter what the position. Einhorn has tried to create a culture opposite to investment banking, where he first worked for a couple of years. He found this culture to be oppressive, with long hours and a lot of disrespect given to the younger people starting at the company. He learned a key life principle in that if you go through a bad situation, you can vow to do the opposite, rather than repeating the negative situation for others.
Financial crisis
The 2008 financial crisis was the result of a series of systematic financial issues which came to a head. Einhorn outlined these as institutions that were deemed to be “too big to fail” and thus, could take as much risk as they wanted. In addition, there was a lot of hidden risks, as many believed credit risk was being transferred, but it was not. There were also the credit rating agencies that were slow to react and had some corruption.
Einhorn believes we should not just have three central credit rating agencies, such as Moody’s (MCO, Financial), Fitch and Standard & Poor's, as they tend to follow each other. Derivatives were also a major point of contention during the financial crisis. We have created a “clearing house,” but this creates another “too big too fail risk.” As a result, the guru believes the bailouts “swept issues under the rug” and could lead to another financial crisis in the future.
Final thoughts
Einhorn loves the investing game and trying to “solve the puzzle” of understanding different companies. As a disciplined contrarian, he has managed to stick to his strategy, which proved to be successful in 2022. His fund is facing a tough time in 2023, which has mainly been driven by the huge market rally that has crushed his short positions.
Regardless, Einhorn is the type of investor to not let one bad quarter or year divert him from his long-term strategy.
