David Einhorn: Don’t Be Afraid to Change Your Investment Thesis
Knowing when to change an investment thesis on a particular asset or company is a major obstacle for individuals. Investors often only seek out opinions that confirm their own views instead of challenging them. It may feel good to surround yourself with analysts, commentators, and other people that agree with you, but this confirmation bias is hazardous to your money. One popular hedge fund manager reminds market participants that when conditions change so should your thesis.
David Einhorn, president and founder of Greenlight Capital, recently issued his latest quarterly letter to investors. The hedge fund superstar notes that his funds have averaged 19.5 percent on an annualized basis since May 1996, and his long positions in the fourth quarter modestly outperformed the broad market. He also announced a new position in a familiar name.
In the fourth-quarter, Einhorn added several new long ideas to his holdings, including a new “large position” in Micron Technology (NASDAQ:MU), a global leader in semiconductor memory chips, such as DRAM and NAND Flash. Interestingly, this is not the first time that Einhorn has been involved with Micron Technology.
“This isn’t our first go-round with MU; it was a large short position from January 2001 to February 2005,” explains Einhorn. “Back then, DRAM was a lousy industry with too many competitors selling an undifferentiated product, often below cost.” He goes on to remind readers that in the beginning of 2001, he highlighted that Micron Technology was valued at 6.5 times current run-rate revenues and generated zero profits.
Einhorn tried to justify Micron Technology’s valuation in 2001 with the help of a bullish sell-side analyst, but he failed to provide a rationale for buying the stock. As the chart below shows, shorting Micron was quite profitable for Einhorn as shares plummeted and remained depressed for several years. However, Einhorn does not allow his previous success cloud his outlook. In fact, he has done a complete turnaround as conditions have changed.
“As for MU, a decade of poor results exposed every flaw in the business and killed any love for the stock. The sell-side groupthink has reversed: the mostly bearish analysts now contort themselves to justify earnings estimates that are too low, price targets that are too pessimistic, and stock ratings that are too negative,” explains Einhorn. “We established a position in MU at an average price of $16.49, marking the first time we have taken a long position in a company in which we once had a material short position. The industry has changed and so has MU.”
In 2014, Einhorn expects Micron to approach $4 per share of earnings and free cash flow while using excess cash flow to reduce the amount of shares outstanding, instead of building new factories. “MU and its competitors have signaled that they will refrain from adding capacity and will instead prioritize economic value-add,” writes Einhorn. As more investors “appreciate the new dynamic,” Micron should enjoy a better multiple.
Earlier this month, Micron reported that revenues from sales of DRAM surged 69 percent in the first quarter of fiscal 2014 compared to the prior quarter. This was due primarily to an increase in sales volume resulting from the acquisition of Elpida in 2013, a Japanese chipmaker. Einhorn believes the acquisition marked the “end of a decade of consolidation from roughly a dozen major DRAM players.”
As Einhorn demonstrates, you should always be ready to change your investing thesis if the underlying fundamentals change. A stock that made you money in the past for one reason can make you money in the future for a completely different reason. In the early stages of a major change, you may be required to go against the general consensus, but the results can be very rewarding.
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