Book Summary of Fooling Some of the People All of the Time: A Long Short Story

Fooling Some of the People All of the Time is an absolute thrill! The book is a long story of legendary investor David Einhorn’s short position in Allied Capital (hence the title).

A Short Summary of a Long Short Story
In short, David presents Allied Capital, a small business lender, as a short candidate during a conference in 2002. The short thesis is based on multiple factors, but the business’ fraudulent accounting and the spreading of false information appeared to be the main reasons David foresaw the stock’s inevitable downfall. As a result of the speech, David and his firm Greenlight Capital were slandered by Allied’s managent team, who demanded that David be investigated for stock manipulation. The next six years were nothing short of a war between Greenlight Capital and Allied Capital. The story involves obvious neglect from government agencies due to Allied’s political network; stolen phone records ordered by Allied, and FBI’s unwillingness to look into the matter; countless cases of fraudulent behavior; theft of taxpayers’ money; and lots of other head-shaking stories that’ll leave you furious, yes, but at the edge of your seat, too!.

Rather than focusing on the details of Greenlight’s war with Allied, I would rather highlight a few points from the book that’ll help the reader appreciate David’s value investing approach.

Greenlight’s Investing Framework
David explains that “traditional” value investors look at a given security in order to determine whether it’s under or overvalued. A typical investor would run a screen with filtering criteria that are typically associated with ‘cheap’ stocks, i.e. low P/E, P/BV or P/S ratios.

Greenlight Capital is not a “traditional” firm: “We start by asking why a security is likely to be misvalued in the market. Once we have a theory, we analyze the security to determine if it is, in fact, cheap or overvalued. In order to invest, we need to understand why the opportunity exists and believe we have a sizable analytical edge over the person on the other side of the trade.” (p. 14) I could imagine (note, I don’t know) that David would look at a macro event, a political change, some industrial challenges or opportunities that could cause or have caused a ‘disruption’, i.e. a large decline that ensured attractive prices or prospects of a great rise that may cause the stocks to be undervalued. Having established the factors that could bring about mispricings, David would delve into the stock(s) in question to determine if it/they truly is/are undervalued.

Speaking of mispricings, David desires really mispriced bargains (as do we all, right?): “Our goal is to make money, or at least to preserve capital, on every investment. This means securities should be sufficiently mispriced, so that if we are right, we will do well, but if we are mostly wrong, we will roughly break even.” (p. 16) This quote illustrates many classic value investing principles: never loose money, have the patience to strike only when a substantial margin of safety is offered, bet big when you find a mispriced asset and don’t be afraid to run a focused/concentrated portfolio.

Speaking of value investing classics, another cornerstone of Greenlight’s investing framework is an absolute return mindset: “In assessing an investment opportunity, a relative-return investor asks, “Will this investment outperform my benchmark?” In contrast, an absolute-return investor asks, “Does the reward of this investment outweigh the risk?” (p. 17) Again, I might be reading into David’s words, but I believe Greenlight doesn’t feel pressured to outperform the S&P500; if there simply isn’t any attractive ideas, they’ll wait for the “fat pitch”, since the reward has to outweigh the risk.

About Being Right and Wrong
In length of the discussion I presented in last week’s book summary of Market Wizards, David has too learned not to let pride keep him invested in a position. Namely, if his investment thesis doesn’t pan out, he doesn’t become stubborn: “[We] avoid “evolving hypotheses.” If our investment rationale proves false, we exit the position rather than create a new justification to hold.” (p. 17)

Conversely, one should have conviction in one’s ideas. If you know you’re right, as David did with Allied Capital, you should hold on as the truth will prevail: “Fraud can persists for a long time, and investors, analysts, and the SEC miss things. But, sooner or later, the truth wins. If you know you are right, all you need is patience, persistence, and discipline to stay the course.” (p. 42)

Besides these insights into David’s investing approach and a first-row seat to a full-out business war, you’ll witness world-class research. The depth of David’s analysis into Allied is mind-blowing. Though the book is a story, it’s a very educational one at that.