What Is the Einhorn Effect?

What Is the Einhorn Effect?

The term Einhorn effect refers to the sharp movement of a public company's share price in response to comments or trading activity by hedge fund manager David Einhorn. Einhorn is the president and co-founder of Greenlight Capital.

The phenomenon usually applies to the drastic drop in share prices immediately after Einhorn publicly shorts or bets against that company’s stock. His comments may also affect share prices, whether positive or negative. In some cases, if investors expect to hear news about a company from Einhorn and don't, they often take it as a positive sign, and the stock price rises.

Understanding the Einhorn Effect

Einhorn founded his hedge fund in 1996 when he was 27 with a significant investment from his parents. He increased the fund's assets under management (AUM) from $900,000 to $7 billion between 1996 and 2018, with average annual returns of nearly 15.4% during that time. In addition to its high returns, his hedge fund is known for its rigorous research and analysis.

Investors started to take notice of his success and began turning to him as a guide for their investment moves. This translated into the development of the Einhorn effect. As noted above, share prices generally respond to the positions Einhorn takes in companies. So if he bets against a certain company, its stock price plummets. He is known for making bold and seemingly unlikely bets that turn out to be correct, such as:

• Allied Capital: Shorting the company's stock in 2002, Einhorn claimed it had fraudulent accounting records. This led to an 11% drop in the company's share price. The Securities and Exchange Commission (SEC) proved him right five years later.
• Lehman Brothers: Einhorn also famously shorted the company in 2007, telling investors it was overleveraged. This proved to be true when the company collapsed in 2008.

Einhorn's sway also reaches the market and investors whenever he speaks (or doesn't) about certain companies. If he reacts negatively to company news, it can have a similar impact on a company's share price. For instance, Einhorn criticized Chipotle in 2012 over its possible employment of undocumented workers and the competitive threat it faced from Taco Bell. This resulted in a 7% drop in Chipotle's share price within minutes of his analysis.

The Einhorn Effect in Recent Years

Einhorn's investment effect waned from 2017 through 2020. His flagship fund returned only 1.6% in 2017, compared to 19.4% for the S&P 500. Einhorn explained what went wrong to shareholders in his annual letter that year, saying the "biggest losers for the year were our short positions on the 'bubble basket.'"

Einhorn said he believed that Amazon (+56%), Athenahealth (+26%), Netflix (+55%), and Tesla (+46%) seemed to be priced with very little margin for error at the beginning of the year. But they failed to meet any of the fundamental expectations in 2017.

In July 2018, Greenlight's AUM dropped to $5.5 billion compared to 2014 when it was over $12 billion and In January 2019, Einhorn's fund reportedly lost 34% in the previous year. As of December 2020, the fund reportedly lost 34% in value since 2015.

However, as of August 2022, Greenlight garnered a positive 13.2% return for the first half of 2022, compared to a 20% decline for the S&P 500 index during the same period.

Example of the Einhorn Effect

The most famous example of the Einhorn effect was an 11% drop in the stock price of Allied Capital in 2012, a company that described itself as a business development firm. During his speech, Einhorn:

• Charged Allied Capital with using aggressive valuation techniques to spin underperforming assets like Velocita, a telecom partnership between AT&T and Cisco, as profitable entities
• Objected to its payment-in-kind scheme in which it received debt or securities as interest or repaid principal on its loans, a practice that had the danger of placing it on the hook in case of a default by the borrower

Another example occurred in 2012 with crushed gravel and stone company Martin Marietta Materials after Einhorn recommended shorting the stock in a speech at the Ira W. Sohn Investment Research Conference. That same year, nutrition supplement company Herbalife felt the Einhorn effect after investors speculated he was shorting the stock based on questions he asked during an earnings call.