Time To Go Long David EinhornSubmitted by Silverlight Asset Management, LLC on May 10th, 2018
“Apparently, now I’m a verb,” the billionaire founder of Greenlight Capital told the audience at the Value Investing Congress in 2013. He flashed an article with the word “Einhorned” in the headline.
That same year, David Einhorn was ranked 44th on Time’s 100 Most Influential People List. He epitomized what it meant to be a hedge fund rockstar.
People didn’t just listen when Einhorn spoke—he moved markets. In 2002, he gave a speech at the Sohn Investment Research Conference where he disclosed his short thesis on Allied Capital. The stock fell 20 percent the next day.
Six years later, his legend grew after he publicly quarreled with the CFO of Lehman Brothers, arguing the bank was using misleading accounting procedures. Lehman famously filed for bankruptcy in September 2008.
Einhorn started his hedge fund in 1996 with $900,000 under management. Today, the firm manages over $7 billion and has averaged 15.4% net return since inception.
Falling out of synch with the market
Einhorn has had a tougher time navigating the current investment cycle, though.
In 2015, after Greenlight lost 20%, the firm wrote the following in their client letter:
"There are lots of simple theories about what went wrong and what we can or should do about it. Everyone wants to help. Even one of David’s children suggested, ‘Dad, why don’t you just short your longs and long your shorts?’ If only it were that easy…”
A lot went wrong for Greenlight in 2015. For example, the firm was short the fangiest of FAANGs—Netflix and Amazon. Meanwhile, Greenlight’s long book failed to own any of the top 50 best performing stocks in the S&P 500.
Fast forward to 2018—history is repeating itself. Einhorn’s main fund reportedly fell 1.1% in April, bringing its year-to-date loss to 14.9%. That compares to a 0.4 percent total return for the S&P 500 Index. Einhorn lamented on a recent conference call that his 20 biggest long positions fell 5.6 percent in the first quarter, while his 20 largest shorts also lost 5.5 percent.
So the kid’s advice a few years ago—effectively “do the opposite”—would’ve ironically produced better results year-to-date.
How the investing game works
Skill is a lot harder to discern in markets than other competitive arenas.
In basketball, for example, a novice stepping on a court to play Lebron James knows they’re outmatched the moment they lay eyes on him.
On any court, even on his worst day, Lebron can dominate over 99% of the planet in a game of one-on-one.
Competition in the investing domain is very different.
- You don’t see your competition. When you buy or sell a stock, the person on the other side of the trade is anonymous. It could be your Aunt Martha, a robot, or Warren Buffett. You have no idea who they are or how well informed they may be.
- Luck masquerades as skill. Anyone can get lucky with a few stock picks. One way to test skill is to ask: can you fail on purpose? Lebron has rehearsed the mechanics of how to make a free throw shot. If asked, he could easily apply different mechanics and miss. That’s because he’s truly skilled. Novices who win on a few stock picks can feel good about that, but few can define their specific process for how they got it right and duplicate it, let alone reverse it and succeed on the short side.
- No one dominates all the time. A 60 percent batting average is good enough to qualify for the Stock Picker’s Hall of Fame. That means you can be wrong 40% of the time and still be a standout performer. No manager or style outperforms every year. None.
Investing in David Einhorn
As a money manager, my process focuses on trying to identify quality assets trading at discounted prices. I think that description applies to Einhorn as a money manager.
Despite a few years of tough performance, I still think he’s a quality investor. Doubters may suffer from recency bias.
What if Greenlight had the same cumulative performance numbers, but the firm was on a relative performance hot streak in recent years? Investors would likely be clamoring to put money with the firm.
It’s unlikely that Einhorn just got lucky his first two decades managing money. Or forgot how to invest.
Einhorn has unusual forensic accounting skills and a sterling reputation for conducting thorough research. Whether right or wrong—he always does his homework. That’s because he has a humble appreciation for the competition.
"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.” – David Einhorn, Fooling Some of the People All of the Time
If you subscribe to the belief investors learn more from losses than wins, as I do, Einhorn is probably a better investor today than he was five years ago.
Finally, it just hasn’t been Einhorn’s season.
Einhorn is a value investor who generally favors cheap, out of favor securities. The value discipline has worked well historically, but there are value cycles and growth cycles. The last bull market was a value cycle. This bull market is a growth cycle. The cycles tend to shift every 7 years or so. We’re due for value to assume the leadership mantle again soon.
Also, the 2000-2010 period in which Einhorn made a name for himself was the worst decade in the history of the U.S. stock market. Even weaker than the 1930s. Hence, it’s no coincidence hedge funds became popular during that time. ‘Hedging’ had utility.
The environment has shifted since 2009—it’s been nine consecutive years of a rising stock market. Hedging has mostly been a drag on performance.
The season will change again, however. And when it does, the truly talented hedge fund managers should shine again. Especially those with strong shorting ability.
Einhorn has said, “On my best days, I fancy myself a combination of Dad’s persistence/patience and Mom’s toughness/skepticism.”
My bet is he has the mental toughness to persevere through these current dark days, and he will emerge on the other side, and knock it out of the park again.
There are two ways you can go long Einhorn. You could become a client of Greenlight Capital, of course. Or, you can go long Greenlight Capital Reinsurance (GLRE), which is my play.
GLRE provides property and casualty reinsurance underwriting. Essentially, GLRE is a leveraged play on Greenlight Capital. The company uses its float from policy holders to invest, and Mr. Einhorn’s firm, DME Advisors, runs the entire investment portfolio.
Here’s how the math works. At the end of 2017, the GLRE portfolio managed by DME was $1.36 billion. Shareholder’s equity was $831.32 million. So for every dollar of equity in the book, a GLRE shareholder gets about $1.60 invested in the portfolio, or 1.6x leverage.
Currently, GLRE trades at a price-to-book multiple of 0.8x. The only years the P/B multiple has traded under 1.0x are 2008, 2015, and this year. Basically, Greenlight’s roughest years.
There are always underwriting risks for any insurer. But if we assume normal underwriting results, and a conservative rebound in Einhorn’s investment performance over the next five years (8% at Greenlight Cap, which implies around 12% ROE for GLRE), book value per share should climb to at least $30 per share. If shares trade at book value, that implies nearly a double from the current stock price.
It’s challenging at this stage of the market cycle to find investments with realistic potential to deliver 15% annualized returns over the next five years. Going long David Einhorn may be one idea that fits the bill.
*Originally published by Forbes. Reprinted with permission.
Disclosure: I oversee accounts which own Greenlight Capital Reinsurance (GLRE). This material is not intended to be relied upon as a forecast, research or investment advice. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by Silverlight Asset Management LLC to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by Silverlight Asset Management LLC, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.