5th Annual New York Value Investing Congress Day 1: Part 2

David Einhorn, Chairman, Greenlight Capital
Liquor Before Beer, In the Clear

Einhorn opened his presentation with his thoughts on the importance of learning from bad decisions.  He cited his 2005 IRA Sohn conference presentation on the merits of homebuilder NBC Holdings, which ultimately fell 40% as the homebuilding sector collapsed.  Although the rest of the sector fell much further, an average of 70%, Einhorn learned the following:

• It is not reasonable to be agnostic about the big picture,  a macro view is vital
• Even given the above statement, you can still be a stock picker

Einhorn went onto give a stirring speech about what he believes to be the current macro risks:

• The government is too focused on the short-term, too focused on getting re-elected.
• Too much focus on special interests (protection of banks, for one)

Einhorn believes that the lesson of the Lehman collapse, a company that he very successfully shorted, is that companies should not be so big that their collapse can jeopardize the entire financial system.

He went onto state that he has changed his view about the validity of owning gold, given its propensity to perform well not just during inflationary times, but when monetary policies are poor in general.  In terms of form of ownership, Einhorn owns physical gold, believing that to be even more efficient than the ETF.

 

Joel Greenblatt, Managing Partner, Gotham Capital
Formula Investing with a Value Mindset

Greenblatt, author of “The Little Book That Beats the Market”, presented a re-cap of his concept of the “Magic Formula”, which utilizes earnings yield and return on invested capital as the criteria to select stocks that will outperform. While he admitted that historical return on capital is backward looking, he stated the importance of estimating future ROC. 

Greenblatt described two periods of underperformance by the strategy:

• 2/1/2006 through 12/1/2008 (34 months)
• 5/1/2002 through 6/1/2003 (13 months)

Despite his somewhat self-deprecating depiction of the Magic Formula, the returns utilizing the strategy have been outstanding.  For instance, using back tested data, the strategy returned 291% or 14.6 % annualized, for the 10-year period ended 5/30/2009.  During the same period, the S&P 500 Index was down 2% (-0.2 % annualized). Furthermore, the Magic Formula has outperformed the market for ten of the past eleven years, through 9/30/2009.

Despite the simplicity of utilizing the Magic Formula, Greenblatt’s data suggests that it is not a good candidate to use for identifying short candidates.  For instance, going long the top decile of Magic Formula companies and short the bottom decile substantially increases portfolio volatility, and does not enhance return.

 

Jonathan Heller, CFA