Billionaire David Einhorn shared his latest views regarding the markets and individual stocks in his 2019 Q3 investor letter. You can download a copy of it here. Greenlight Capital returned 24% during the first 3 quarters of 2019 and outperformed the S&P 500 Index ETFs by 3.5 percentage points. Our calculations showed that the top 20 most popular stocks among hedge funds returned 24.4% in 2019 through September 30th and outperformed the S&P 500 ETF (SPY) by 4 percentage points. So, we can confidently claim that equity hedge funds’ stock picks are performing better than passive investment strategies this year.
David Einhorn mentions his top 5 stock picks in his investor letter but he starts talking about Brighthouse Financial (NASDAQ:BHF) first. Here is what he said about this stock:
“When we started in this business, there were over 7,000 listed companies in the United States – most of which we didn’t know. When we received a stock pitch, we often had to begin by asking, “What do they do?” We wondered who were the people following all these businesses. Even so, while some tickers had little Wall Street research coverage, there always seemed to be somebody paying attention and reacting to news. Today there are about half as many listed companies in the U.S. as when we started, and yet in certain situations we are sometimes left wondering if there is anybody paying attention, let alone reacting.
We raise this because of the curious case of Brighthouse Financial (BHF). Last quarter, we explained how bearish analysts had estimated that BHF had suffered up to a $1 billion loss due to declining interest rates. We disputed that analysis and thought the loss would be much smaller. Coming into the earnings report, BHF traded poorly amid further rate declines, as it appeared that most market participants accepted the bearish analysis.
What happened? When the company reported its second quarter, not only was there no $1 billion loss, BHF actually grew its capital buffer by $400 million. In the early part of the year and again in June, management added to its interest rate hedges and purchased cheap options that protected the balance sheet through the subsequent interest rate declines. Usually, when an advertised bear case doesn’t come to fruition, the stock tends to soar. Relative to BHF’s $4 billion market cap, the $400 million capital build when the market had expected a large loss ought to have had a large positive impact on the share price. In this case, the market yawned. The glass half-empty crowd concluded that if the hedges generated gains in a falling rate environment, those gains would probably be reversed if rates went back up.
Management made it clear on the conference call in August that the further declines in rates since quarter-end did not erode its capital buffer. While it should be obvious, the greater level of interest rate hedging makes BHF much less exposed to interest rates. Yet subsequent to the announcement, the correlation between BHF stock and interest rates has increased.
As one analyst put it in his summary of the quarter, “we do not expect there to be many buyers for this name despite a seemingly cheap valuation and reasonably good earnings results.” But someone has been buying: with the stock in the doldrums, BHF continued its aggressive buyback program, repurchasing nearly 3% of outstanding shares in May and June alone, and management collectively purchased nearly $1 million worth of shares on the open market after the earnings report in August. During the quarter, the shares advanced from $36.69 to $40.47, making BHF our second largest winner.”
We took a closer look into Brighthouse Financial in detail in our premium monthly newsletter a year and a half ago. After that we published an article about it. The stock was trading at $40 and 5.4 times “forward earnings” at the time. We determined that BHF was a value trap and didn’t recommend a position in the stock. Time proved us correct. BHF shares didn’t deliver any positive returns over the last 1.5 years and currently change hands at $39 whereas the stock market hit an all time high on Friday. A stock trading at 5.4 times “forwards earnings” should earn nearly 30% of its market cap in 1.5 years. Did BHF do it in the last 1.5 years? Does it currently trade for 4 times its forward earnings excluding cash? You need to answer these two questions affirmatively before considering a long position in this stock.
We don’t have space left to discuss Einhorn’s remaining top 4 stock picks in detail. Einhorn’s favorite stocks (in addition to BHF) are listed as AerCap Holdings (NYSE:AER), Altice USA (NYSE:ATUS), General Motors (NYSE:GM) and Green Brick Partners (NASDAQ:GRBK). You can download a copy of Einhorn’s letter here to read his comments about these stocks.
Disclosure: None. This article is originally published at Insider Monkey.
