DAVID EINHORN: Value investing isn't dead, it's just out of favor
Hedge fund billionaire David Einhorn, who identifies as a value investor, has struggled to perform in a market that’s continued to rise.
“Despite it being a good year for the market, it was a challenging environment for our investment style,” Einhorn wrote in an investor letter dated January 16. “We do not mimic any index and we think ‘outside the box.’ We have a value orientation and we take comfort from the margin of safety afforded by the low valuations of our long investments. Though most people understood our last quarterly letter as tongue-in-cheek and while we certainly don’t believe value investing is dead, it is clearly out of favor at the moment.”
Greenlight Capital fell 1.6% in the fourth quarter, bringing the fund’s year-to-date returns to 1.6%. Meanwhile, the S&P 500 (^GSPC) gained 6.6% in the fourth quarter, ending the year up 21.8%.
“While it feels like we have been running face first to the wind, we don’t intend to capitulate and are sticking to our strategy of being long misunderstood and shorting ‘not value,'” Einhorn wrote.
The fund’s biggest losers in 2017 included its so-called “bubble basket,” which consists of short bets against high-flying momentum stocks including Amazon (AMZN), Netflix (NFLX), Tesla (TSLA), and athenahealth (ATHN).
“It’s tough to look at a full year of losses on Amazon (+56%), athenahealth (+26%), Netflix (+55%) and Tesla (+46%) when we believe all those stocks appeared priced with little margin for error entering the year, and none executed well or met fundamental expectations in 2017,” he wrote.
Has the market adopted an alternative paradigm?
In the prior quarter’s investment letter, Einhorn raised an interesting question about valuation.
“Given the performance of certain stocks, we wonder if the market has adopted an alternative paradigm for calculating equity value,” Einhorn wrote in a letter to investors dated October 24. “What if equity value has nothing to do with current or future profits and instead is derived from a company’s ability to be disruptive, to provide social change, or to advance new beneficial technologies, even when doing so results in current and future economic loss?”
Value investors like Warren Buffett and finance academics would argue that a company’s true intrinsic value can be derived by discounting its projected future profits. Of course, it’s almost impossible to accurately forecast a company’s future profits. Furthermore, it’s widely accepted that a company’s market price in the short-run is affected by other factors including investor emotions.
One of the most widely-reported signs that the market as a whole is expensive is the cyclically-adjusted price-earnings ratio (CAPE), a measure of stock market value popularized by Nobel prize-winning economist Robert Shiller. CAPE is calculated by taking the S&P 500 and dividing it by the average of 10 years worth of earnings. It has a long-term average of just over 16. Currently, CAPE is just above 33, which some view as trouble. The only other times CAPE climbed like this was before the market crash of 1929 and the bursting of the tech bubble in the early 2000s.
Julia La Roche is a finance reporter at Yahoo Finance. Follow her on Twitter.