David Einhorn’s 2022 letter to investors.
The full PDF can be viewed here and at the bottom.
Our successful performance on the short side was extremely diversified and broad based. Therewere two individual single-name shorts that had caused losses in earlier periods that werematerial winners in 2022. We also had gains in a sector ETF, equity index shorts and severaldifferent baskets of bubble and “innovation” stocks that we implemented in 2021 and 2022. Wehad no material losers in the short portfolio.While we will continue our current policy of not discussing individual shorts, we will reviewthe performance of our long-standing bubble basket short strategy. Historically, we haveavoided so-called valuation shorts, because valuation by itself is rarely a catalyst. After all,twice a silly price isn’t twice as silly.However, during the 1998-2000 bubble, we recognized that shorting bubbles can be quiteprofitable when they burst. Though we didn’t expect to ever see another bubble like that oneagain, we were wrong. When we saw a second mega-bubble forming, we wanted to participatein the subsequent decline.Gates Capital Management Reduces Risk After Rare Down Year [Exclusive]Gates Capital Management’s ECF Value Funds have a fantastic track record. The funds (full-name Excess Cash Flow Value Funds), which invest in an event-driven equity and credit strategy, have produced a 12.6% annualised return over the past 26 years. The funds added 7.7% overall in the second half of 2022, outperforming the 3.4% return for Read More
We define a bubble stock as one that if we look at the company’s current and projectedfinancials – counting stock compensation as an actual expense – and perform a traditionalvaluation analysis, it could fall at least 80% and still not appear cheap to us. The goal is to shortwhen the bubble appears to have popped. 2013 was a year of enormous gains for a number ofspeculative stocks. In early 2014, the bubble appeared to be breaking and we created our firstbubble basket. This proved to be very premature.In our bubble baskets, individual positions are small and names come and go. There were sixtyeight stocks in the original 2014 bubble basket, which we built up to 13.8% of capital at cost.During our holding period, forty-two were profitable shorts while twenty-six were unprofitable.Though eleven of the stocks fell more than 50%, thirteen rose more than 50% and eight of themdoubled or more. To our surprise, several of these names did in fact grow eventually into their2014 valuations.Through the end of 2016, the basket was profitable. But 2017-2019 was a different story. Wehad covered a number of the winning bubble stocks and concentrated our risk on the names thathad not yet worked. This was a mistake. Ultimately, we covered the remaining stocks from thisbasket during the COVID crash in March 2020. This basket lost money, with cumulativenegative impact to our returns of 11.3% of capital spread over several years.We believed that during COVID the re-inflated bubble began to pop in September 2020. Weinstituted a second bubble basket with fifty-eight names totaling 20.7% of capital.Unfortunately, the bubble had one more leg up. Convinced that we were again early, we coveredour 2020 bubble basket in early January 2021. The losses on this basket were 2.1% of capital.Looking back on these names, six were subsequently acquired at an average price that was 45%over our entry. However, of the other fifty-two names, the average stock at the end of 2022 wasdown 42% from our entry price, with only nine up from our entry price, while nine fell morethan 80%.We are nothing if not persistent. In March of 2021, we again believed that the bubble hadpopped… this time correctly. We created our third bubble basket with thirty-one names totaling6.5% of capital. This bubble basket remains in the portfolio, though we have covered somenames. All but one of these stocks are down through year-end from our entry, with anastounding twenty-four of them down more than 70%. The cumulative positive impact on ourreturns has been 3.0% of capital.In early 2021, we also identified an actively-managed ETF of so called “innovation” stocks thatappeared to us to have significantly similar characteristics to our bubble names. We shorted abasket comprised of the components of that ETF in February 2021 that we ramped up to 9.0%of capital. It has declined by 76% from our first entry. The cumulative positive impact on ourreturns has been 6.4% of capital.Finally, in January 2022, we turned from cautious to bearish. We identified our fifth bubblebasket of thirty-one names, and instituted a 6.0% combined short position. This basket alsoremains in place. As of year-end, twelve of the stocks have fallen at least 50% and only one stock is positive with a 23% gain. The cumulative positive impact on our returns from our 2022bubble basket has been 2.4% of capital.To bring it together this is the contribution of the bubble basket strategy to date:4
