What is the Einhorn Effect?

The Einhorn effect is the sharp drop in a publicly-traded company’s share price that often occurs immediately after hedge fund manager David Einhorn publicly shorts (bets against) that company’s stock.

The Einhorn effect can also occur in reverse when Einhorn does not mention a company about which he previously expressed bearish remarks. If investors are expecting to hear something negative from Einhorn and then don’t, they often take it as a positive sign, and the stock price rises.

However, Einhorn’s positive pronouncements about companies don’t tend to push their share prices upward; instead the Einhorn effect mainly applies to stocks that he shorts (and makes this short position known to the public).

Key Takeaways

  • The Einhorn effect is a sharp drop in a stock's price after public criticism of its practices by noted investor David Einhorn.
  • The most famous example of Einhorn effect is a double-digit percentage drop in Allied Capital's stock after Einhorn criticized it at the Sohn conference in 2002.
  • In recent times, the Einhorn effect has lost some of its edge with the poor investment performance of his fund.

Understanding the Einhorn Effect

Einhorn founded his hedge fund in 1996 at age 27 with a significant investment from his parents. He increased its assets under management from $900,000 to $10 billion over the next 18 years, with average annual returns of nearly 20%. In addition to its high returns, his hedge fund is known for its rigorous research and analysis. Despite his reputation as a short seller, Einhorn’s hedge fund is usually long overall.

Some of Einhorn’s famous shorts include that of lender Allied Capital in 2002, which he claimed had fraudulent accounting records. The SEC finally proved him right five years later. He also famously shorted Lehman Brothers in 2007 and told investors it was over-leveraged, which the world learned was true when the company collapsed in 2008. Einhorn is known for making bold and seemingly unlikely bets that turn out to be correct.

A less dramatic example of the Einhorn effect than the Allied and Lehman scenarios occurred in 2012 when Einhorn criticized Chipotle over its possible practice of hiring undocumented workers and its competitive threat from Taco Bell. Chipotle's share priced dropped 7% in the following minutes following Einhorn's analysis.

Another example that same year occurred 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.

Einhorn Effect in Recent Years

Einhorn's halo has disappeared in recent years with poor investment performance. In Jan 2019, CNBC reported that Einhorn's fund had lost 34 percent in the previous year.

On July 4, 2018, the Wall Street Journal reported that Greenlight's assets under management (AUM) had dropped to $5.5 billion; by way of comparison, the AUM in 2014 was over $12 billion.

2017 was yet another year of severe underperformance - his flagship fund returned only 1.6%, compared to 19.4% for the S&P 500 Index. In his annual shareholder letter for 2017, Einhorn explains what went wrong. An excerpt: "The biggest losers for the year were our short positions on the 'bubble basket'...[including] Amazon (+56%), athenahealth (+26%), Netflix (+55%) and Tesla (+46%) when we believe all those stocks appeared priced with little margin for error entering the year, and none executed well or met fundamental expectations in 2017."

With those picks as shorts, it is no surprise that his influence has been on the wane. The Einhorn effect may fade out of existence entirely if he continues to lose in such shocking fashion. On the other hand, as a value investor, he may get the last laugh if his analysis of "overvalued" stocks turn out to be correct.

Example of Einhorn Effect

The most famous example of Einhorn effect was an 11% drop in the stock price of Allied Capital, a company that described itself as a "business development" firm. During his speech, Einhorn charged Allied Capital with using "aggressive valuation" techniques to spin under-performing assets like Velocita, a telecom partnership between AT&T and Cisco, as profitable entities. He also objected to its "payment-in-kind" scheme in which it received debt or securities as interest or repaid principal on its loans. This practice had the danger of placing it on hook, in case of a default by the borrower.