In our earlier interview, David Einhorn, president of Greenlight Capital, spoke about Allied Capital, the SEC, and the ongoing threat to our financial system. In this second part, he discusses his investing process and some of his favorite stock ideas.
John Reeves: How do you find ideas, and how do they end up in one of your funds?
David Einhorn: Our ideas start with a story. Is the market missing something that we see? Once we find an idea, the due diligence starts. We try to uncover a mispricing, and then we invest. Despite our reputation, we are predominantly long investors.
Reeves: Can you give us an example of a long idea where you see something the market does not?
Einhorn: Yes, one is Delta Lloyd -- it's a Dutch insurer. The market is focused on its low growth prospects, and on its ability to sell insurance to new customers. The market fails to see its ability to manage its resources well. Overall, it's a well-run business that has been able to increase its book value significantly. Despite being able to grow its book value, its stock price is lower than where we bought it. At about half of book value and six times earnings, it is the only stock in my portfolio that I think if it doubled, it would still be cheap.
Reeves: What do you look for on the short side?
Einhorn: We look for companies that are misunderstood, overvalued, and have deteriorating performance. We tend to avoid shorting open-ended growth stories. We also look for improper accounting practices.
Reeves: What is your view of Netflix
Einhorn: On the surface, Netflix, as a growth story, wouldn't fit our short criteria. And it isn't one of our short positions. That said, I think Whitney Tilson made some good arguments that were stronger than those put forward by Reed Hastings. I did like the way Reed Hastings responded, however. It was very professional. Their debate was a healthy exercise, and we need more of that going on in the market. Hastings' comments, though, were that his business looks good in the short term. He didn't seem to have good responses to the longer-term criticisms, like what will happen to the cost of content. The Netflix story will be an interesting one to watch.
Reeves: Here at the Fool, we have a new Rising Stars program that allows writers and analysts the opportunity to manage money publicly on Fool.com. What are your thoughts on developing investors?
Einhorn: Interesting. We have a program called Greenlight Masters that is a fund of funds. We've invested in a dozen or so managers, some of whom are "day one" managers without track records. So we're willing to invest in managers without multiyear track records. We think there's an opportunity there.
Reeves: How about a quick game of "Buy, Sell, Hold?" First up, China.
Einhorn: Oh, I don't know what to say on China. There are a lot of smart people with compelling, but different, views on China, and I haven't done the work to analyze it on my own. So I just don't know.
Reeves: Buy, sell, or hold: the S&P 500
Einhorn: Not sure -- there is a wide range of outcomes on both sides. But our approach is to construct a portfolio that is capable of producing attractive returns with a variety of different outcomes.
Reeves: Do you think ordinary investors should be aiming for absolute returns, as opposed to relative returns?
Einhorn: Yes, each investment should be assessed on whether it will provide a return that more than compensates us for the risk we are taking. A relative return approach, where you just want to exceed a benchmark, is vastly inferior, in my opinion.
Reeves: Buy, sell, or hold: Bank of America
Einhorn: I wouldn't own any banks right now.
Reeves: Thank you very much for your time today.
Einhorn: Thank you.