3 Pieces of Investing Advice from a Billionaire Fund Manager – Part 1

When it comes to money management, David Einhorn’s likely one of the best in the business. This is why: Since Einhorn stared his investment firm Greenlight Capital in 1996, it has generated an annualised return of just over 19%.

To put that number into perspective, a $1,000 investment in 1996 that’s compounding at 19% would have become nearly $23,000 by 2014. Einhorn’s achievements as an investor has led him to accumulate a fortune of some US$1.75 billion today, according to Forbes.

Recently, I chanced upon an old January 2011 interview that my Foolish colleague John Reeves had conducted with Einhorn. There are two parts to the interview (see here and here) and it contains some great takeaways for retail investors like you and me.

For the sake of brevity, I’ve broken the takeaways into three parts. Here’s one of them.

On the need for investors to protect themselves

John Reeves: What are the lessons for retail investors from the story of Allied Capital?

David Einhorn: The takeaway for retail investors is that they should be appropriately skeptical of the various gatekeepers that are supposed to be there to protect them. The gatekeepers such as the SEC and sell-side analysts might not be acting on their behalf.

Retail investors shouldn’t just assume a seal of approval from the SEC because it hasn’t brought any action against a company, for example. And sell-side analysts often have huge biases that aren’t aligned with ordinary investors.”

The back-story to the exchange above concerns Einhorn’s multi-year struggler with Allied Capital, a firm that provides financing solutions for small businesses.

In 2002, Einhorn made a presentation of his short-thesis (when you go short, you’re betting that a stock would fall) on Allied Capital at the annual Ira Sohn charity investing conference. He believed that Allied Capital had some serious accounting issues and was improperly valuing its illiquid securities.

Allied Capital fought back and started throwing mud at Einhorn, so much so that the Securities Exchange Commissions (SEC), the U.S.’s financial markets regulator, started investigating him for potential wrongdoing.

It took five years before Einhorn was finally vindicated. In 2007, Allied Capital was found to have violated securities laws by the SEC. A year later, one of Allied Capital’s investments in its portfolio went bankrupt. When all was said and done, Allied Capital had sold itself to another financial institution at a price that was nearly 90% lower than its peak in 2007.

(For those of you interested, Einhorn had documented his fascinating fight with Allied Capital in the book Fooling Some of the People All of the Time.)

Coming back to Einhorn’s interview with John, what was shared in the quote above is the importance of how investors should depend on their own judgement to protect themselves from questionable investments. Another of my fellow Fools, Stanley Lim, has a great real-life example to back this up.

Stanley had invested in China-based apparel retailer Eratat Lifestyle Ltd (SGX: FO8) back in 2012 when it was valued at less than the cash it had on its balance sheet net of all debt.

But, he soon sold his shares when Eratat did something really odd. In June 2013, Eratat sold some bonds at an effective annual interest rate of around 16.7% per year. Those were onerous interest rates, especially when considering that (1) the bonds would mature in only two years, and (2) Eratat was flush with cash just prior to the bond issue. Eratat was subsequently found to have been a fraud in late 2014.

Stanley, having been alert to the proverbial cockroaches in the kitchen, was quick to act and escaped unscathed.

That’s all for now. For the other two parts, check out below!

On the need to dig deeper into your own investments check out here.

On the need to not follow even the best investors blindly – check out here.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any companies mentioned.