Investment Lesson from “Deflate-gate”
Both poker and investing are games of incomplete information. You have a certain set of facts and you are looking for situations where you have an edge, whether the edge is psychological or statistical. – David Einhorn
David Einhorn, who is the founder and president of Greenlight Capital, manages a $10 billion “long-short value-oriented hedge fund.” David started Greenlight Capital in 1996 with only $900,000 and he has generated roughly a 20% annualized return for investors. David has taken advantage of misinformation from the media and used his edge to post outsized gains. The media has recently turned its attention on deflate-gate. We will describe how Einhorn would make an investment decision using incomplete information on the subject of deflate-gate.
We believe that if the New England Patriots were a publicly traded company it would represent a once in a lifetime buying opportunity. The biased media coverage would have scared investors into a selling panic of Patriots shares. Since it is best not to invest with emotions, analyzing the known facts is your edge. Value investors use a method of discounting cash flows or calculating the asset value/replacement of a business. If the intrinsic value that they calculated is less than what the company is trading for in the open market than it’s a potential new buying opportunity.
The media has a very good track record of misinforming and confusing the public into making terrible investment decisions at some of the most inopportune times. As we have seen from much of the coverage of “deflation-gate”, many media members have labeled the Patriots as cheaters and liars. This rush to judgment may have tarnished the franchise brand and tainted the reputation of their hall of fame coach and quarterback but only temporarily. For an investor trying to determine whether or not to buy the Patriots stock, they would need to gain an advantage by taking all the known facts in the story and arriving at their own decision.
The one piece of information that they would need to make an investment decision would be to try and determine what happened to the air pressure in the football during the first half of the Patriots AFC championship playoff game. An astute investor would buy an NFL football and conduct their own experiment and put the ball through vigorous tests in different weather environments. One way to calculate the change in air pressure would be to calculate a physics equation called the Ideal Gas Law (pV=nRT). This would give the value investor a statistical edge much the same how David Einhorn calculates the intrinsic value of a company. David would not rely on CNBC to give him a gut feeling whether or not to buy or sell. In the case of the Patriots, an investor would not watch and listen to ESPN talking heads test a football by throwing it around an indoor studio at room temperature.
If you were making this investment, you have done your due diligence and determined the probability of the football losing air in cold weather conditions and calculated the physics equation of the Ideal Gas Law. If the facts support your view that the Patriots are innocent than you have gained a statistical edge on incomplete information. Your new investment will have a huge payoff when the team is exonerated and the best part of it is that you just bought into one of the most successful teams in NFL history. Much like David Einhorn, we believe that the most appropriate way to make an investment decision is by using fundamental analysis rather than relying on the biased media for recommendations.
Go Pats!
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