David Einhorn warns of the danger from independent investors in valuation

Tesla TSLA was Greenlight Capital’s worst performing position in 2020 as a famous investor; David Einhorn has written several times about why he considers the title to be great shorts. Most of the fund’s losses came in the first half of the year, as the company adjusted its position before Elon Musk’s company was added to the S&P 500 index last month.

Owning Tesla shares is a fad

In his fourth quarter letter to investors, Einhorn says that if owning Tesla cars were a fad, the company would sell a lot more vehicles than it does. He added that the trend was to own Tesla shares, reminding investors when he previously said that “twice a stupid stock price isn’t twice as stupid, it’s always just stupid.” David warned 20 times of a ridiculous price and recalled that Cisco Systems CSCO peaked at 29 times its revenue during the dot-com bubble of 2000, which would still be a reduction from Tesla.

He also reflected on why stocks might trade at “20 times a ridiculous price”, adding that “it is possible that we are just wrong and wrong in measuring silliness.” Putting this possibility aside, he believes that some stocks are held only by investors indifferent to valuations.

David notes that one of the first concepts investors learn is market capitalization, which is the price of the stock multiplied by the number of shares outstanding. Analyzing valuation means comparing market capitalization to different indications of value such as current and future income, earnings, cash flow, and asset value.

When he talks about investors indifferent to valuation, he is talking about those who do not see valuation as part of their investment process. They don’t want, can’t, or choose not to include valuation as a factor.

I don’t want, I can’t or I will choose not to

Einhorn says the most valuation-indifferent investors are index funds, noting that the more overvalued a stock, the more index funds are required to buy. He said passive investing is so prevalent now that index investors are no longer “price takers”, buying at the price set by active investors trying to determine the correct value. Instead, demand from passive investors sets the price, which he says “challenges the whole premise of passive investing.”

Investors who cannot consider a valuation are the large number of retail investors who have no training in valuation. In the past, brokers or financial advisers limited their influence by providing advice and determining relevance. However, the rise of platforms like Robinhood allows any investor to start trading without paying a commission. The founder of Greenlight said that many investors in this group believe that an “expensive” stock is a stock that changes hands at $ 100, while a “cheap” stock trades at $ 5.

The final group is made up of professional investors who have decided that valuation is not part of the investment process. Einhorn points to a remark by Howard Marks, which says that the attitude of these investors is to “hold on as long as the thesis is correct and the trend is up.” David explains that this group finds it unproductive to wonder if market capitalization exceeds even the best estimates of the present value of future earnings by orders of magnitude.

Disconnected from fair value

Greenlight’s Chief explains that when the last shareholder who includes a valuation as part of their investment process leaves a stock, leaving it to be held exclusively by valuation-indifferent investors, it disconnects from fair value. He said the valuation no longer matters and the share price “might as well be a random number”.

“The only point in observing that various losing companies, without any exclusive benefits, are trading at valuations that imply that they will someday become industry leaders, is to marvel at how the disconnected stock bubble has become. speculative, ”warns Einhorn.

Will Tesla and other tech darlings continue to roar over the mania of speculative investors who prefer stories over fundamentals? That is the million dollar question, or in Tesla’s (almost) trillion dollar case.