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What is value investing?

Simply put, value investing involves seeking out and investing in stocks at a discounted (or undervalued) price. Value investors don’t necessarily invest in the “hottest” stocks but put their money in what they consider to be value companies with long-term potential.

It’s certainly worked for Warren Buffett, who used the strategy to amass his whopping $136.4 billion fortune. Buffett has always said he looks for companies that have a competitive advantage, including factors like a strong brand, a sizable customer base, and a rather high barrier to entry. For example, an early investment pick of his was GEICO Insurance company, which grew dramatically, until he eventually acquired it.

Einhorn used to follow the same value investing strategy as Buffett. However, now he argues that “market structures are broken and value investing is dead,” regardless of what some billionaires believe.

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How Einhorn’s investing strategy differs from value investing

Einhorn founded Greenlight in the mid-1990s and made a reputation for himself as a value investor. But since then, the industry has changed drastically — in particular, the number of money managers actively paying attention to stocks has plummeted.

Einhorn theorizes that means managers can no longer expect to get the same returns they once did, leading him to make the stunning declaration that “investors don’t care about valuations” anymore.

He says his new strategy involves seeking companies that rather than undervalued are actually misunderstood, offering the example of Apple in its early days. Some investors saw just a hardware company, but Einhorn says he sensed it also had potential as a software company and a services company.

Because of that misunderstanding of what Apple brought to the table led to the company being undervalued early on, Greenlight was able to make a tidy profit off its rise.

And so with that in mind, Einhorn says his fund made some modifications to its approach.

  • Discipline on price: Instead of focusing on long-term gains, he now focuses on price discipline, which means buying stocks with lower earnings multiples.
  • Emphasis on cash flow: He seeks out companies with strong cash flow, often coupled with stock buyback programs. So, if other value investors don’t recognize the value, at least shareholders will still see cash flow from stock buybacks.
  • Concentration: Rather than extensively diversifying his portfolio across a wide array of say 500 companies, he chooses to stick to around 15 to 20 companies which he believes have the potential to outperform others.

As for deciding whether the traditional value investing or Einhorn’s approach makes the most sense for you, there are a few questions you’ll want to ask yourself first:

  • What are my investing goals?
  • Am I looking for long-term gains or rather short-term cash flow?
  • Do I want to invest in a very wide array of companies, or am I comfortable investing in a narrow array of companies?

If you’re still unsure, it never hurts to consult a professional financial adviser to ensure you’re on the right track for your unique financial goals.

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Adam Palasciano Freelance Writer

Adam Palasciano is a freelance contributor to Moneywise.

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