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We all have heard it: value investing is dead. Stocks like Alibaba and PayPal are classic value stocks with 10 to 15 times price-to-earnings ratios. They are priced significantly lower than the market average and their peers but haven't moved much in the last five years. On the other hand, stocks like Nvidia boast almost 100 times the price-to-earnings ratio, and investors are still pouring money into them. Examples like these have led to the conclusion that the stock market is broken. No one cares about stocks' value anymore. But there is one man who has beaten the odds! David Einhorn, the famous hedge fund manager and founder of Greenlight Capital, is a value investor who has managed to beat the market for quite some time (13% annualized return vs. S&P 500's annualized return of 9% in the last 28 years). In today's episode, I will break down David Einhorn's market-beating VALUE investing method and give you two stock ideas that you may consider researching and buying now. I'm Hoda Mehr, founder, and CEO of Stock Card, and on this blog and its accompanying YouTube channel and Podcast show, I share detailed fundamental analyses and interesting investment stories.
This post is part of our educational series to help you hone your fundamental investing skills. Catch up with past blog posts on How to Invest Like Buffett? How to Invest Like Charlie Munger, or how to Find the Highest-Returning Stocks? Remember, this content is for education and sharing ideas and not advice to buy or sell any securities. Sign up for a free account on Stock Card to get notified of these blog posts, YouTube videos, and Podcast shows every week. We only ask your name and email address when you sign up. Index Investing Is Killing Value InvestingEven David Einhorn believes the stock market is broken and value investing in its traditional sense is gone and may never return. According to Einhorn, for value investing to work, you need active investors in the market who look for discrepancies between stock price and the company's value and who will be willing to invest their capital in those undervalued opportunities. However, because of two structural changes in the market, undervalued stocks could stay undervalued for a long time. Those structural changes are: Passive index investing where no valuation analysis is done. Algorithmic trading with a focus on momentum and upward price movements where, again, there is no room for valuation analysis. In other words, index passive investing and algorithmic trading are killing value investing. Here's David on Bloomberg Television answering the question of when value investing will be back: "I don't I don't know that it ever comes back you know there have been serious changes to the market structure and pretty much most of the value investors have been put out of business so if value investing is trying to do security analysis think about what companies are worth think about why they might be misvalued or misunderstood and then do valuation analysis that tells you that that in fact is true there's just very a few of us left most Market participants these days they either cannot do value they're just not trained or experienced and knowing how to do valuations or they they their structure doesn't allow them to like if they're an index fund or a passive thing the last thing you're you're doing is value or their system is a quantitative system or a trading system or an algorithmic system and or or your style is to just buy things that are have charts that go up into the right right and none of those participants are really doing value so it used to be you know that that on every conference call of every company there were like dozens of analysts from all of these competing long only hedge fund long short people and stuff like that trying to hear what companies were doing and saying and trying to figure it out and and those staffs have been gutted because the world has moved passive and so there's just a lot less competition for what we do." In the old days, value investors would find and invest in companies with low valuations compared to their intrinsic value. When enough value investors pick up the stock, the rest of the market would wake up to the opportunity and invest, too, and that volume would bring the stock price back to the market averages. The value investor who found the stock early would make good money and then repeat the process. These days, none of the price vs value discovery is happening. So, as a value investor, you could find undervalued stocks, and no one could care less about it. Everyone is pouring money into indexes and or trading based on technicals. You'd be sitting on an undervalued stock for an eternity. That's why David Einhorn believes value investing will never be back. How Does David Einhorn's Style of Value Investing Works?But we know David is a value investor, and his hedge fund, Greenlight Capital, has overperformed the market. Mind you, Einhorn is also a short-seller. Some of his fund's return is due to his short positions. At the same time, he has lost money to his short bets, famously, his Tesla short, which he backtracked from. Today, we are focusing on his long-term value bets. His value investing methodology works because he has adjusted it to take advantage of the market's index investing and algorithmic trading structural changes. What David Einhorn explained about the stock market's structural changes logically means there are many undervalued stocks, potentially deeply undervalued stocks in the stock market, that no one cares about, and you can buy them for an extremely cheap price, such as 4 or 5 times price to earning ratio. Then, you need a catalyst for these stock prices to go up. In the past, that catalyst was the rest of the market waking up to the undervaluation. Now, the companies themselves recognize they have a gem on their hands and start buying their shares. An undervalued company that has the cash to buy back its own shares has two advantages: 1) They have savvy management who understands its company is undervalued and is allocating capital to the highest potential investment opportunity, their own stocks, and 2) It reduces share counts, increasing the valuation of the stock, causing upward movement of the prices. Eventually, indices or technical indicators would notice the stock, and then the stock is in for a significant rally. That means the structural changes to the stock market have created a new value investing methodology: Finding companies extremely cheap and screening for those who have the cash and earnings to buy back their own shares, enjoying the higher prices coming thanks to the buybacks, and wait for a long time for the stock to be recognized by the algorithms and indices to pick them up for even higher returns. Here's David Einhorn again, this time on the Money Maze Podcast, explaining his adjusted value investing approach: "You have these washed out securities and if they're trading now, instead of buying it at 10 times earnings because you think that they're going to be, you can buy that same type of situation at four times earnings or five times earnings. And then, you may not know whether it's going to be. If you're wrong by 10 percent a five multiple becomes five and a half. There's nobody who cares anyway. Nobody's going to sell because they missed by 10 percent so. You don't really have to get your forecast right. You need to just start at such a low value and if you do it in unlevered companies that are taking the vast majority of that earnings yield and giving it to you in dividends or BuyBacks this has to work itself out over time in a favorable way if you are buying back 15 of your company the stock goes up or in six and a half years there's no stock left and the last share is the golden share and that's what we want to own." In summary, David Einhorn buys super deep value stocks that don't have a lot of debt, and use their earnings to buy back shares or pay dividends, and hold them for a long, long time waiting for that last batch of stocks that are left and are extremely valuable. Value Stocks To Buy NowOf course, as stock pickers, we can't hear about a methodology that beats the market and not be curious about how to find stocks that meet the criteria. In my research, I learned David Einhorn focuses on small companies, typically under $5B in market cap, with no financial debt and positive earnings, with shareholder-friendly management who allocate some of their earnings to buybacks. You can screen the stock market for companies like that. I used Stock Card's stock screener tool to find stocks like that, using a market cap lower than $2B, strong financial, no cash concerns, and undervalued filters, and I got to roughly 118 stocks that met the criteria. I leave a link to this screener here in case you'd like to continue the research. But, there is a more interesting way to get to a few stocks that meet the criteria. David Einhorn’s Hedge Fund, Greenlight Capital, has to release its holdings every quarter through the 13F filing. Since we know the fund is extremely long-term oriented, what's on the list from the end of the last quarter is still very relevant and a good stock to research and buy if you want to follow this value investing style. From Greenlight Capital's latest 13F, two stocks grabbed my attention: The first one is Kenvue Inc., ticker KVUE, the latest addition to Greenlight Capital’s fund. It is a $36B consumer packaged goods company behind brands such as Neutrogena and Listerine. It's not that small, but it owns iconic brands. The stock is valued at 2.3 times sales and 16 times forward earnings. It generates solid free cash flow and has lots of cash and a rather solid balance sheet. The stock doesn't strictly meet the criteria we discussed a few minutes ago, but it is certainly interesting to research. The fact that not many financial analysts cover the stock means it can be sliding under the radar while it pays a nice 4.2% in dividends. The next stock is even more interesting. It is called Alight Inc, ticker ALIT. Greenlight started buying it in Q4 2023. It is roughly $5 billion in market cap and offers an employee benefits management platform for more than 36 million employees. It reminds me of ADP but in baby stages, but much more technologically advanced. Its core platform is already AI-powered, generates solid recurring revenue, and has an almost 100% retention rate. The stock is priced at 13 times forward earnings, 1.3 times price to sales, and one times book value. This is certainly an interesting company to keep an eye on. I'll be researching this in more detail for my own portfolio. Talking about good stocks to buy now, I discussed how to find quality stocks at a reasonable price two weeks ago and shared a few stocks to buy now based on such investment methodology. If you missed it, it's a good next post to read. I leave a link to it here. I'll see you next time!
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