Warren Buffett’s Proteges Imitate David Einhorn

Warren Buffett couldn’t hire superstar hedge fund manager David Einhorn but the managers he hired can imitate Einhorn’s long stock picks and generate similar results. Warren Buffett’s Berkshire disclosed a $256 million brand new position in General Motors (GM) during the first quarter. David Einhorn was the most bullish hedge fund manager about GM at the end of the fourth quarter. He still had nearly $400 million invested in the stock at the end of March. Here is what Einhorn said about GM in his investor letter:

GM is the largest auto manufacturer in the United States. After the business failed under its legacy high-cost structure during the recession, the U.S. government bailed out the company and took over most of the ownership. Last November, GM completed an IPO of about 30% of its stock at $33 per share. The government continues to own about one-third of the company. After the IPO, the shares initially advanced to almost $40 before retreating. When the shares broke the IPO price, we determined that the shares were attractive, but only purchased a small position, believing that there might be a better opportunity later when the government exited the rest of its stock. Instead, during a weak third quarter where the market punished all cyclical stocks, the shares fell well below the price where we planned to add to our position. We decided that the shares were cheap enough that we were more than fully compensated for the possible overhang of the government’s stake, and we established a position at an average price of $25.78 per share.

GM is being priced by the market as a cyclical company trading at less than 6x this year’s earnings. While some may see it as normal to value cyclicals at low multiples of peak earnings, we believe that 2011 is not a peak and, in fact, is below mid-cycle. Prior to the crisis, U.S. auto sales ran between 15 and 19 million units for many years. While sales have bounced from the recession low to about 13 million units, GM is poised to grow earnings from both a return to mid-cycle volumes, which we estimate to be 15 million units, and from a coming major refresh of its North American product portfolio. The market appears focused on GM’s “legacy liabilities.” However, the new GM does not have pension and healthcare liabilities that are likely to over-run the company. Instead, GM sits with $33 billion of gross cash which represents nearly its entire current market capitalization. We see potential for GM to begin to return capital to shareholders over the next year. While we are cognizant of the various investment risks that include near-term global economic weakness and the government ownership overhang, we think these concerns are more than priced in at current levels and see significant upside even if the U.S. experiences a very slow “new normal” type of economic recovery. The shares ended the quarter at $20.18 each.