Tesla TSLA was Greenlight Capital’s worst-performing position in 2020 as the famous investor; David Einhorn has repeatedly written about why he sees the stock as an excellent short. Most of the fund’s losses came in the first half of the year as the firm adjusted its position before Elon Musk’s company was added to the S&P 500 index last month.
Owning Tesla stock is a fad
In his fourth-quarter letter to investors, Einhorn says if owning Tesla cars were a fad, the company would sell many more vehicles than it does. He added that the trend is owning Tesla stock, reminding investors of when he previously stated that “twice a silly stock price is not twice as silly, it’s still just silly.” David warned 20 times a silly price and recalled that Cisco Systems CSCO peaked at 29 times revenue during the 2000 internet bubble, which would still be a discount to where Tesla trades now.
He also thought about why stocks might trade at “20 times a silly price,” adding that “there is the possibility that we are just wrong and bad at measuring silliness.” Setting aside that possibility, he believes certain stocks are held only by investors indifferent to valuations.
David notes that one of the first concepts investors learn about is market capitalization, which is the share price times the number of outstanding shares. Analyzing valuation means comparing the market cap to different value indications like current and future revenues, earnings, cash flows and asset values.
When he talks about valuation-indifferent investors, he means those who don’t consider valuation as part of their investing process. They either won’t, can’t or choose not to include valuation as a factor.
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Won’t, can’t or choose not to
Einhorn states the most apparent valuation-indifferent investors are index funds, noting that the more a stock is overvalued, the more index funds are required to buy. He said passive investing is so widespread 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 argues “calls into question the entire premise of passive investing.”
Investors who can’t consider valuation are the large numbers of retail investors who have no training in valuation. In the past, stockbrokers or financial advisors limited their influence by providing advice and determining suitability. However, the rise of platforms like Robinhood allows any investor to start trading without paying commission. Greenlight’s Founder said many investors in this group believe an “expensive” stock is one that changes hands at $100, while a “cheap” stock trades at $5.
The last group consists of professional investors who decided that valuation isn’t part of the investing process. Einhorn points to a remark from Howard Marks, who says these investors’ attitude is to “hold on as long as the thesis is right, and the trend is upward.” David explains that this group believes it’s unproductive to think about whether the market cap surpasses even the best-case estimates of the present value of future earnings by order of magnitude.
Disconnected from fair value
Greenlight’s Chief reasons that when the last shareholder who includes valuation as part of their investment process exits a stock, leaving it held exclusively by valuation-indifferent investors, it becomes disconnected from fair value. He said valuation no longer matters, and the stock price “may as well be a random number.”
“The only point in observing that various money-losing companies, without any proprietary advantage, are trading at valuations that imply they will someday become industry leaders, is to marvel at just how speculative the bubble in disconnected stocks has become,” Einhorn warns.
Will Tesla and other tech darlings continue to roar on mania from speculative investors who favor stories over fundamentals? That is the million-dollar question, or in Tesla’s case (nearly) trillion-dollar one.