3 investing lessons from Einhorn's candid letter

Published Thu, Oct 22 201512:06 PM EDT

David Einhorn, the legendary hedge fund manager whose stock picks move markets, had a tough first half of 2015. The third quarter was even worse. His fund, Greenlight Capital, was down 14.3 percent in the third quarter, bringing its returns for the year to a negative 17.1 percent, according to an investor letter sent to clients Wednesday. Einhorn's letters are revered by investors for their transparency, rational analysis and nuggets of wisdom. The latest missive did not disappoint as the fund's poor performance caused Einhorn to candidly examine how he invests. Here are three key investing lessons for the regular guy from the hedge fund manager's letter. "Given our results this quarter, this is a good time to discuss our process. First, we are value investors. This means that we buy what we believe are misunderstood companies at low valuations relative to their underlying assets and future cash flows." Einhorn explained they spend much time analyzing the financial statements of every potential investment to figure out if the current stock price is properly valuing the economics of each business. Read More Intel's data center warning to hit these stocks And only after there is a significant discrepancy between their valuation and the market's do they enter a position. "Because we look for investments that have a healthy margin of error, a misjudgment of analysis is rarely a disaster. We don't need much to go right in order to make money, and in many cases we can get a lot wrong and still break even." This margin-of-error philosophy is similar to the margin-of-safety principle followed by Warren Buffett, where they look for skewed risk-reward opportunities. "Our philosophy is to invest the most capital in ideas where we have the most conviction. The core of our process for both finding stocks and sizing our investments has not changed and has historically served us well." Einhorn believes capital is best invested in concentrated portfolios, which are likely to get the most leverage and performance from their best, well-researched ideas. "With any large loss, we reassess the position to evaluate whether our thesis is busted or the losses are overblown. Depending on what we determine, we either add, hold, trim or exit. Sometimes, patience is in order and sometimes it's not." All investors go through difficult stretches when positions move against them. Einhorn explains this is where they need to reassess what happened, rationally decide to buy more or admit they got it wrong and move on. Einhorn said Consol Energy and SunEdison as examples where he believes his theses are still intact. The fund manager cited how Consol Energy went through a large cost-cutting effort and announced positive drilling results in July in Utica shale. The company can be cash-flow positive with its leaner model even if commodity prices go lower, but the stock trades as if Consol is in financial distress, according to Einhorn. Read More The force is with these 'Star Wars' stocks On the other hand, he raised the white flag on Micron Technology , saying he and his analysts did not anticipate the collapse in PC demand and overestimated flash-memory sales. Consequently, Einhorn's firm decided to lower its position in the stock. Even with his rough year, Einhorn still has adherents and defenders. "No investing strategy works at all times. If you look at investing factors, such as growth, quality or value, value has underperformed more recently. You could add that luck can work either way short-term," Nick Mazing of Ampera Capital said in an e-mail. He added, "2015 will probably be just a dip in Mr. Einhorn's long-term record. His fundamental research process as described in his book, letters and slides is something that all investors can learn from." Einhorn ended the letter with a list of his five largest long positions as of the end of September: Apple , Consol Energy, General Motors , gold and Resona Holdings . — With reporting by CNBC's Scott Wapner

David Einhorn

Adam Jeffery | CNBC

David Einhorn, the legendary hedge fund manager whose stock picks move markets, had a tough first half of 2015. The third quarter was even worse.

His fund, Greenlight Capital, was down 14.3 percent in the third quarter, bringing its returns for the year to a negative 17.1 percent, according to an investor letter sent to clients Wednesday.

Einhorn's letters are revered by investors for their transparency, rational analysis and nuggets of wisdom. The latest missive did not disappoint as the fund's poor performance caused Einhorn to candidly examine how he invests.

Here are three key investing lessons for the regular guy from the hedge fund manager's letter.