September 24, 2012

David Einhorn - He who predicted the fall of Lehman Brothers in 2008


Beginning
Most investors and traders remember the fall of Lehman Brothers in 2008 with horror, but the hedge fund manager, David Einhorn, made money from the crash. David Einhorn was born in 1968 and graduated in 1991 from Cornell University with a degree in Government. He has been described as an independent, original thinker who isn't afraid to stand on the conviction of his ideas.
    After finishing his college degree, David Einhorn wanted to work for the CIA, but decided to work for the investment bank Donaldson, Lufkin & Jenrette. He didn't like the job, and instead he joined the hedge fund SC Fundamental Value Fund where he worked until he founded the hedge fund Greenlight Capital with $1 million in 1996. Originally he wanted to get a PhD in Economics, but he got rejected from every program to which he applied to. 
    David Einhorn is a board member of the charity organizations Michael J. Fox Foundation and the Robin Hood Foundation. The Robin Hood Foundation was founded by the hedge fund manager Paul Tudor Jones and the goal of the foundation is to help poor people in New York. One other contributor to the foundation is George Soros - another hedge fund manager - who gave a contribution of $50 million to the foundation in 2009.
    While not analyzing stocks, David Einhorn plays Bridge, but he's most famous for being a skilled poker player. In 2006, he finished in place 18 in the World Series of Poker, and he finished in 3rd place in the 2012 World Series of Poker Big One for One Drop Tournament. One note here is that he gave the price money to different charity organizations. He has also paid $250,100 in a charity auction to have a lunch with the famous investor Warren Buffett. Poker and investing are actually not that different from each other. "Both poker and investing are games of incomplete information," he said. "You have a certain set of facts and you are looking for situations where you have an edge, whether the edge is psychological or statistical."

On his own
The hedge fund Greenlight Capital is long-short, value-oriented, and has generated more than a 20 percent annualized net return for its partners and investors. Today, the hedge fund manages about $7 billion of capital.
    David Einhorn is famous for criticizing the rating agencies. Moody's sovereign risk team has only four professionals covering twenty countries in Asia and the Middle East. Moody's does not have a long-term quantitative model that incorporates changes in the population, incomes, expected tax rates, and so forth. They use a 12-18 months short-term outlook to analyze data to assess countries abilities to finance themselves. David Einhorn criticized them because they lower the rating of a country or company after an event has happened. Two examples here are Lehman Brothers and AIG. The rating agencies Moody, Standard & Poor, and Fitch Ratings all maintained at least A ratings (a good rating) on AIG and Lehman Brothers up until September of 2008. Lehman Brothers later had to shut down, and AIG had to be rescued with a large bailout. If these three large rating agencies couldn't see that these companies were bankrupt - why do we need these rating agencies? "The truth is that nobody I know buys or uses Moody's credit ratings because they believe in the brand, they use it because it is part of a government-created oligopoly and, often, because they are require to by law," David Einhorn said.
    One other investment made by David Einhorn was Apple. Greenlight Capital bought the Apple stock in 1999 at $14 per share, and later sold the shares for $18 in 2000 - a profitable investment. Apple is currently trading at $700 per share. Greenlight Capital later purchased Apple again, but at a much higher price. 
David Einhorn is negative to the Japanese debt-mountain and believes that the probability of a Japanese debt default is high. Japan may already be past the point when Japan can't reduce its ratio of debt to GDP over any time horizon, and thus can never repay its debts. The Japanese debt is currently financed by its own population. The problem is that the population in Japan decreases as the population get older because of demographic issues, and a smaller population can't finance a growing debt.  
    One asset David Einhorn is positive to is gold. Gold is often being criticized for just sitting in a vault earning no interest - but how much interest can you get on the bank account today? "But then I look at the other major currencies," he said. "The Euro, the Yen, and the British Pound might be worse. So, I conclude that picking one of these currencies is like choosing my favorite dental procedure. And I decide holding gold is better than holding cash, especially now, where both earn no yield."
    Gold is not a bet on inflation or deflation. Gold does well when monetary and fiscal policies are poor and does poorly when monetary and fiscal policies appear sensible. One should buy stocks in great companies, but David Einhorn believes that there's also room in the portfolio for some gold.

Strategy
What David Einhor learned from his younger years at SC Fundamental Value Fund was to understand:
  • The nature of the business
  • The economics of the business compared to reported earnings
  • If the managements decisions are aligned with shareholder interests - David Einhorn doesn't like managers who don't answer questions directly
One of the analyzes made by Greenlight Capital is available in the book Fooling some of the people all of the time written by David Einhorn himself. The first chapter of the books gives a brief introduction to who David Einhorn is, and the rest of the book describes why the stock of the company Allied Capital is going to crash. David Einhorn began analyzing the company in 2002, but he had to wait until 2008 before the stock finally crashed. The shares of Allied Capital fell with 50 percent before the company was purchased in 2009 by Ares Capital.
    Greenlight Capital try to make money when a stock is moving up and when a stock is moving down, and they generally have a portfolio of companies with both types of long-short investments. The portfolio is always net-long - they have more long positions than short positions. In 2013, the average distribution between the positions looked like this: 109 percent long and 72 percent short.

Conclusions
  • It may take a very long time before the underlying value of a company is reflected by the stock price. David Einhorn analyzed the company Allied Capital in 2002, but had to wait until 2008 before Allied Capital finally crashed. The famous investor Peter Lynch always said that it takes between 3 and 10 years before the underlying value of a company is reflected by the stock price.
  • Professionals make mistakes. Both David Einhorn and Peter Lynch missed the large gains of the Apple stock. 

Source: Wikipedia, ValueWalk, Huffington Post, GuruFocus, Reuters, Bloomberg, Washington Post, New York Times, Scribd

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