David Einhorn investing strategy: Bet big when high conviction opportunities come along: David Einhorn

Billionaire hedge fund manager David Einhorn says the most important factor in investing success is critical thinking.

“If I had to pick one, I think it would be critical thinking skills. It is the ability to look at a situation and see it for what it is, which is not necessarily what is presented to you. And if something makes sense, find out what makes sense. And when something doesn’t make sense, to question it, to challenge it, to look at it from a different perspective, often to come to the opposite conclusion,” he said in an interview with a financial website.

Einhorn says investors need to bet big when high-conviction opportunities arise.

“You don’t have to do that often. Most of the time, when someone tells you something and it makes sense, it just makes sense. And that’s that. But sometimes it really doesn’t make sense… And if maybe just a couple of times a year you come to a view where you have a major disagreement with what everyone else thinks about a certain situation when you figure that out and find out that it matters. We’ve been able to make a small number of large investments that, in most cases, have worked very well,” he says.

David Einhorn is known in the financial markets as an activist investor and excellent short seller. He has long been recognized as one of the most successful and respected hedge fund managers in the financial industry.

He is famous for correctly betting on a short position in Lehman Brothers before it collapsed during the financial crisis.

Einhorn is also President and Co-Founder of Greenlight Capital Inc. After receiving his BA from Cornell University’s College of Arts and Sciences in 1991, he began his career in 1993 at the hedge fund Siegler, Collery & Co.

Greenlight Capital is a New York-based hedge fund founded in 1996 by David Einhorn. From inception in May 1996 through the end of 2016, the fund has returned 16.1%, significantly outperforming the S&P 500.

Einhorn’s firm invests in both long and short-term stocks, but is best known for short selling. He uses a long-short equity strategy, taking long positions in stocks that are expected to rise and short positions in stocks that are expected to fall. The company implements the strategy depending on whether an asset has been determined to be undervalued or overvalued.

The Fund analyzes various aspects of the investment market including quantitative analysis, annual filing reports and market sentiment.

The unicorn effect

The “unicorn effect” is what investors call the impact that David Einhorn’s comments on markets and specific stocks have on their prices.

The market often reacts sharply to Einhorn’s public statements about stocks, coining the term “unicorn effect.”

investment strategy

Einhorn follows value investing principles and has developed a twist on the regular value investing process. He first finds reasons for a likely mispricing of assets and then does the traditional value investing analysis instead of doing the traditional value investing analysis first.

According to Einhorn, reasons for an asset’s mispricing include spin-offs, accounting issues, and changes in secular or technological trends.

“We’re taking the process of the traditional value investor and flipping it a bit. We start by identifying situations where there’s a reason why something could be misunderstood, where investors probably haven’t properly understood what’s going on. Then we do the more traditional work of confirming that there is indeed an attractive investment. That’s as opposed to starting with something that’s just cheap and then trying to figure out why. We think our way is more efficient,” he says.

Einhorn is a strong believer in taking long positions in companies he thinks are undervalued and selling stocks in companies he thinks are overvalued or have accounting issues.

He looks at a company’s intrinsic value to generate consistent returns.

According to Einhorn, an investor’s job is to find mysteries in situations that involve various combinations of risk, uncertainty, and ignorance.

He says that the process of discovering riddle answers is inherently probabilistic.

“What I like is solving the puzzles. I think you are dealing with incomplete information. you have little things You have facts. You have an analysis. You have numbers. You have people’s motivations. And you’re trying to piece that together into a puzzle — or deciphering the puzzle in a way that if you get the puzzle right, you have a better-than-average chance of doing it well, and that’s the best part of the business,” he says.

Einhorn shared some valuable investment tips that can help investors achieve exceptional success.

Avoid losses
Einhorn says investors’ goal should be to make money, or at least preserve capital, and not lose money on any investment.

“Securities should be sufficiently mispriced that when we’re right, we’ll do well, but when we’re mostly wrong, we’ll be about even. The trick is to avoid losers. Losers are terrible because it takes a win to even them out just to be even again,” he says.

Be patient

According to Einhorn, the goal of a value investor is to buy the assets at a bargain price and then wait patiently.

“Trying to forecast short-term rather than wait and see is foolish, and value investors rely instead on the combined long-term effects of buying with a margin of safety, knowing that prices will revert to the mean over the long term,” he says.

Avoid “too hard”

Einhorn says if an investment is too difficult, investors should just move on to the many other opportunities that aren’t difficult.

“Why would you get involved in investing where you don’t know what you’re doing, especially when there are other bets where you’re doing it? Playing against weak opponents is not a sin in investing or business. There are no bonus points in investing when you’re doing things that are really hard,” he says.

Have a solid process

Einhorn says that a good process can lead to a bad outcome in the real world, just as a bad process can lead to a good outcome.

“Both good and bad luck can play a role in the investment of outcomes. But the best investors know that a solid process will outperform over time,” he says.

Choose wise

According to Einhorn, having the ability to make the best choice at a later date when investors have more information is valuable because markets are constantly changing.

“I firmly believe in not making decisions before they have to be made. Circumstances change, people change, facts change, and options change. Why commit early when you can decide later with more information?” he says.

Avoid leverage
Einhorn says the biggest challenge for investors is dealing with unknown unknowns, ie risks that are uncertain in character and magnitude but definitely exist.

He says that in order to manage these risks, a principle investors can adhere to is to avoid financial leverage.

“We manage risk based on the level of investment we make. We are not leveraged. We’re not borrowing more money to make more investments. In this way you avoid risks or control your risk. If you never have to pay anyone back, you’re not subject to the terms of the loan,” he says.

Diversification is important
Einhorn says that even the very best stock ideas aren’t guaranteed to work, as any company can have a number of hidden risks that investors are unaware of.

That’s why diversification is so important, he says, not because investor analysis might be bad, but because even the best analysis in the world might not be enough to make the right conclusion in the face of the unknown.

He suggests investors have a risk management system and set limits on how much losing position they can afford to hold.

Reevaluate investments from time to time
Einhorn says investors should reevaluate all of their investments to find out whether they’ve performed well or not.

He says that once investors figure that out, they should sell or downsize investments they’re no longer interested in.

“Some that didn’t work we abandon or reduce because we decide that what we thought is no longer true or is unlikely to be born. We change positions accordingly and we do it position by position and whether it’s going well for us or not, that’s part of our ongoing process,” he says.

Take advantage of market extremes

According to Einhorn, market extremes occur because investors do not make independent decisions and are not perfectly informed rational agents.

“The longer your investment horizon and the lumpier returns you are willing to accept, the happier you will be and the better your returns will be,” he says.

Let your investment strategy challenge you

According to Einhorn, investors should encourage other peers to counter and challenge their investment thesis from time to time, which will surely help them improve their strategy and achieve investment success.

(Disclaimer: This article is based on the various interviews by David Einhorn)

Leave a Comment