David Einhorn’s New Approach To Value
I attended a popular (and expensive) value investing conference in London recently. Fortunately, I was a guest of David Einhorn so I didn’t have to pay. It was a good event, although not as good as last year which I wrote up extensively. One speaker told me that he used up his best idea last year and he didn’t have as good an opportunity set this year – that seems strange, given that there appear to be a lot of value stocks on offer right now.
Einhorn was the keynote speaker and he participated in a fireside chat, before doing an extended question and answer session. He continues to believe that there aren’t enough value investors left to make a difference to valuations.
His former strategy was very similar to the special situations strategy I followed at the hedge funds. You find a stock on 12x earnings whose earnings have been under-estimated by the market. The earnings are then revised up by 20% and the stock gets rerated from 12x to 15x. This delivers you a 50% return in 18 months or sometimes 70-80% in a 2-3 year timeframe.
Einhorn told us that no longer works. Typically, these situations were picked up by an analyst at a large mutual fund which would take 6 months to buy a position and would absorb all the sellers’ stock. Today, those mutual funds no longer have steady inflows and a constant need for new ideas. They have lower AUM, lower research budgets and are simply not around to buy these cheap stocks in sufficient volume.
He says the sell-side analysts don’t matter, they don’t have any money and they don’t have enough customers to make a difference. Passive simply overweights the dearest stocks and underweights the cheapest stocks. Money chases performance so value managers don’t have any AUM.
He sees a wasteland of under $5bn market cap stocks trading reasonable volume which are simply being overlooked. He can buy a stock at 5x P/E and it doesn’t even matter if he gets the forecasts right because if they miss by 10%, there is nobody left to sell!
The marginal buyer then becomes the company itself through buybacks or private equity. One example was his former holding Atlas Air which was taken out by private equity at 6x earnings and a discount to book. It’s a great deal for them and even though he feels that it warranted a 40% higher price, he is not fussed because he made 90%!
He gave one example of a stock he currently owns which is generating cash flow of 20-25% of its market cap and is in the middle of buying back over half its stock, yet its share price hasn’t moved. Paying subscribers will be able to read all about it at the end of this post.
Einhorn is excited about the present environment. He cited stocks with mid single digit P/Es and double digit buybacks and said:.
“You don’t usually get these prices except at the bottom of a bear market or in the middle of a recession”
Einhorn on Selling
When asked about selling positions, which is almost always trickier than buying stocks, Einhorn had some great advice:
If you think you are wrong, you should sell the entire position immediately – don’t wait! It’s very tempting to wait for a better exit and you can lose out by doing so.
If the stock goes, up, there is nothing wrong in selling some. If you sell 15% of your position two weeks later, the stock is 10-15% lower, you can then buy back that 15%, something you would not otherwise have done.
If you feel like bragging about a position, you should sell some. Similarly, if a friend calls up and congratulates you on a trade, sell some.
Einhorn was asked about selling out of his Victoria’s Secret position. He explained that new management had come in and moved to a strategy of making the lingerie more attractive to women of different body shapes. Their survey work said that it was killing the company’s reputation and damaging the brand and they therefore exited.
Einhorn was asked his thoughts on the macro environment. He believes that we have moved from a deflationary to an inflationary environment. There is a risk in developed markets that the fiscal situation could topple because we have too much debt and interest rates could cause a problem.
He likes gold because the US has $30tn in debt, bad demographics and a 6% deficit when there is 3% unemployment – that is a big drain on the Treasury. He has multi-year inflation swaps which with gold are his main macro positions.
He doesn’t have strong views on the US economy, there is a high degree of uncertainty with a wide range of possible outcomes. These range from no recession at all, his current view, to a hard landing.
His portfolio is now 85% US, 15% Europe. He will also look at other developed markets like Canada and Australia and Japan although he has no positions there now. He avoids emerging markets as he doesn’t have the necessary feet on the ground. He has 50-60% in his top 5 positions.
Einhorn was asked about the property sector and gave a long and interesting answer. He pointed out that the sector is illiquid and difficult to mark; it had outsized risk-adjusted returns for a long time, fuelled by low rates and a strong economy. That attracted a lot of capital and caused shrinking cap rates.
Today, we have 20% vacancy rates in the office sector – only 80% of the stock is in use when we have 3% unemployment. That space is not going to be filled. Rent rolls are going from positive to negative because of the vacancies – when leases come up for renewal, it’s easy to threaten to move to the office next door at a discount.
Hence very significant losses are to come, even on conservatively financed projects. There will be a lot of ownership changes as the equity will disappear and this will take several years.
Government relaxed anti-trust provisions 30 years ago and the US has an increasingly monopolistic society which is a disbenefit – for example, his housebuilder faces a cement monopoly in one region. Jonathan Tepper wrote a good book on this subject, The Myth of Capitalism.
Paying subscribers can read on for David Einhorn’s stock pick. They will also get another stock idea next Sunday when there will be no free edition of the newsletter.
I should also mention that the launch offer for A Walk Through Apple’s 10-K ends very soon. If you’d like to learn how to read a 10-K properly and save $100, use the coupon code FREESUB before it expires on May 31. Paying readers save even more – there’s a reminder of your promo code further down this post.