The worst-performing high-profile hedge fund in 2018 was David Einhorn (Trades, Portfolio)'s Greenlight Capital, according to initial performance figures that have been released over the past week. Indeed, these initial figures suggest Greenlight Capital lost 34% in 2018, the worst performance in the fund's 22-year history.
Multiple factors contributed to Einhorn's dire performance in 2018, but he did make at least one sensible decision: to sell Apple Inc. (AAPL, Financial).
Time to get out
I always like reviewing the decisions of famous investors, no matter how they turned out, to try and learn some lessons from those who are supposed to be the best and brightest on Wall Street.
At the time, Einhorn's decision to sell his stake in Apple was met with skepticism. Why was the billionaire manager selling one of his best-performing positions when the rest of the portfolio was struggling?
As it turns out, it looks as if Einhorn made the right decision, contrasting sharply with Warren Buffett (Trades, Portfolio)'s decision to dramatically increase his stake in the company.
Here's how Einhorn described the decision to sell in his third-quarter letter to investors:
"On August 31, we sold the last of our Apple (AAPL, Financial) stock at $228 per share. Our first purchase was on May 10, 2010 at a split adjusted $36 per share. For a number of years it was the largest position in the Partnerships. Our AAPL investment compounded annually at 26% and earned the Partnerships over $1 billion."
As it turns out, Einhorn sold right at the top of the market and, after compounding at a rate of 26% per annum over the holding period, the fund was able to book significant profits on this position.
Einhorn first started buying, as noted above, in May 2010 and continued to build a position throughout 2011 even though the consensus was against the company. As he describes in the letter:
"After Steve Jobs passed away in October 2011, the consensus view was that the company would never innovate again. Then in 2012, Samsung beat AAPL to market with a smartphone with a larger screen and AAPL stock collapsed by 45% in seven months. Very few agreed with us on AAPL, and we had an initial loss on our investment."
The driving force behind the investment was that the company had more strings to its bow than just the iPhone and would continue to innovate. Meanwhile, it had a steady stream of income from its other hardware and software services, giving it plenty of maneuverability to pursue a different set of growth objectives:
"Our variant perception was that the iPhone was not a commodity piece of hardware that would face ruinous margin degradation, but a mix of hardware, software and services that integrated with other AAPL products and benefitted from AAPL’s developer ecosystem and its positive network effects. Rather than a commodity, we thought that AAPL was an affordable luxury product with a durable brand. The market obviously disagreed and shares sold off to about 5x earnings net of the cash."
After successfully building the business after Jobs' death, and regaining the market's trust, the stock rallied and Einhorn decided to sell:
"We ultimately sold because our differentiated thesis from 2011 has become consensus, the valuation at 17x forward earnings is much less enticing, and we are somewhat worried about Chinese retaliation against America’s trade policies."
I think there are several takeaways from this post-mortem.
First, there are plenty of similarities with the situation the company faces today and what it faced in 2011. In addition, it shows the power of buying high-quality businesses with a durable moat and recurring income stream at low prices. Einhorn had done the work on Apple's brand power and customer loyalty and he was willing to make a significant commitment toward the business based on this judgment.
Further, there's a lesson here about how important it is to take profits at the right moment. Einhorn could have let the position run, but he decided his original thesis had run its course and headwinds were building against the company.
As it turns out, this was the right decision. I wouldn't be surprised to see him getting back into the stock if it continues to trade at discounted levels.
Disclosure: The author owns no stocks mentioned.
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