For most stock investors, last year was a year of stock market losses.
But not for the well-known value investor David Einhorn – it was his best year ever.
While the leading stock index S&P fell around 20 percent for the year, David Einhorn had a positive return of over 36 percent.
In other words, he did more than 50 points better than the dominant index, and in hedge fund parlance, this is called being 50 points of alpha.
David Einhorn Bet on a Bear Market in 2022
David Einhorn describes in a letter to his investors that he has long seen a bubble in the stock market. He says he went from being cautious in 2021 to being bearish in January 2022.
The fund created different baskets of companies that they shorted, and these baskets of shorts have helped to give the fund an extraordinarily good return.
Part of the story is also that he has had some difficult years leading up to 2022, precisely because he shorted while the market was still rising.
Shorting means betting that stocks will fall. It’s a really difficult discipline to manage, because not just your logic, but also your timing has to be right. You lose money when you short if the stock in question goes up – and there are essentially no limits to how much you can lose, as there is no cap on how much a company can increase.
As John Keynes once said: “The market can stay irrational longer than you can stay solvent.”
He Shorted Tesla
David Einhorn doesn’t actually write in the letter to shareholders which companies Greenlight Capital shorted, but he has previously revealed that the fund shorted Tesla. He has quite publicly chastised Tesla and founder Elon Musk.
It sounds like David Einhorn is also critical of the well-known rock star portfolio manager Cathie Wood and her ARK Invest, although he doesn’t say so directly.
He simply writes that Greenlight Capital has shorted parts of an “innovation ETF” – which sounds like Cathie Wood’s project:
“In early 2021, we also identified an actively-managed ETF of so-called “innovation” stocks that appeared to us to have significantly similar characteristics to our bubble names. We shorted a basket comprised of the components of that ETF in February 2021 that we ramped up to 9.0% of capital. It has declined by 76% since our first entry,” he writes.
In other words, his fund has not shorted the entire ETF, but selected companies from it.
Compared to Cathie Wood, his short position in innovation stocks has fared even better.
Cathie Wood’s flagship fund, the Ark Innovation ETF, fell 67 percent in 2022.
When you short, you make money from something falling, so in this regard it is good that the innovation stocks that David Einhorn selected fell more than her fund.
How David Einhorn Defines a Bubble
David Einhorn talks a lot about bubbles in his letter. They’re mentioned around 30 times.
But what exactly is a bubble? How does he define it?
“We define a bubble stock as one that if we look at the company’s current and projected financials – counting stock compensation as an actual expense – and perform a traditional valuation analysis, it could fall at least 80% and still not appear cheap to us,” he writes.
In other words, he and his team are calculating the value of a company. If the stocks of that company were to drop 80%, and it would still be too expensive for them to consider investing in it – then it belongs in bubble territory.
However, they will only start shorting when it looks like the stock will stop rising and instead start falling.
“The goal is to short when the bubble appears to have popped,” he writes.
He Became Famous When He Shorted Lehman Brothers
David Einhorn established Greenlight Capital in 1996 when he was just 27 years old. The fund did very well. He got a good return on shorting the dotcom bubble.
He became known in investor circles for providing some very critical and precise analyses of the companies that he shorted.
In 20o2, he accused the insurance company Allied Capital of cooking the books. The next day, the stock imploded. But he really became famous when he publicly criticized and shorted Lehman Brothers – about a year before they crashed and started the financial crisis.
Today it’s got a name. Investors call it the “Einhorn effect” when a stock falls after David Einhorn made a critical comment about it.
Value Investing May Never Come Back
He writes in the letters to shareholders that the very long bull market from 2009 has thinned out the ranks of his peers.
These years have been tough for David Einhorn too. He has been predicting a bubble and shorting way ahead of time. This bubble has been going on a lot longer than he expected.
For this reason, his fund has lost money some years, and this has meant that investors have fled from the fund, leaving it decimated.
For similar reasons, most investors like him have folded in this period.
“Many investors that have historically had a value bent either adapted, retired or went out of business,” he writes.
He describes how many of his competitors left the industry because value investing became unattractive when everything boomed.
He also says that it’s unlikely value investing is going to make a comeback.
“Value investing, as an industry, is unlikely to ever fully recover. The outflows into passive and other strategies were debilitating,” he writes.
However, in his eyes, this is a positive development for his fund. It means fewer competitors.
“We believe this is positive for our strategy, as we face much less competition than we did a few years ago,” he writes.
Here I would just like to add that not all value investors have negative years when the market is going up. David Einhorn’s strategy of shorting stocks makes him more exposed and vulnerable in a bull market.
I do not short stocks, nor do I recommend that you do.
He Foresees More Stock Market Decline in 2023
Last year was a bad year – but it could get even worse in 2023, David Einhorn believes.
According to him, we are still in the middle of a bear market.
“Although we believe we are in the middle stages of a bear market, we did establish a new medium-sized long position in Tenet Healthcare (THC) during the fourth quarter,” he writes.
What does this mean for you?
Of course, this means that you have to be careful and calculate what companies are really worth. You have to open the accounts and do the math.
David Einhorn asks if it is worth gambling with your savings and your future.
“This was a year where many of those who rode the bubble suffered losses, raising the question as to whether the risks were worth taking,” he writes.
I would add that exactly the same applies to 2023 – and all other years…
Is it really worth taking the risk by gambling? How do you avoid gambling? By familiarizing yourself with your investments, by opening the accounts and seeing what’s under the hood.
You can learn how to calculate a company’s value in my free e-book Free Yourself. Download it by clicking here.