According to David Einhorn (Trades, Portfolio)'s third-quarter letter for investors of Greenlight Capital, the fund's second-best performing stock during the recent three months's quarter ending in September was its fourth-largest position, Brighthouse Financial (BHF, Financial).
I've been following Greenlight's investment in this life insurance group since it first initiated the position in the third quarter of 2017.
So far, it has been a rocky ride for the hedge fund. From its initial public offering price of around $75, the stock plunged below $30 at the beginning of 2019 and has since recovered some of these losses to trade around $40 at the time of writing.
Put quite simply, Einhorn and his team believe that the market does not understand the opportunity here. Life insurance businesses are quite complex to understand because they have many moving parts.
For example, Brighthouse has hundreds of billions of dollars of interest rates swaps and hedges on its balance sheet, which can lead to big swings in earnings and profits.
Value in complexity
According to the hedge fund manager, the complexity of the company's balance sheet has confused Wall Street analysts. Einhorn said as much in his second-quarter letter to investors and revisited the topic in the Q3 letter saying, "Last quarter we explained how bearish analysts had estimated the Brighthouse had suffered up to a $1 billion loss due to declining interest rates." He believed the realized loss would be much smaller.
As it turns out, Einhorn was wrong. The company actually reported a $400 million capital build and net income available to shareholders of $1.4 billion in the fourth quarter of 2018.
The company ended the fourth quarter of 2018 with stockholders' equity of $14.4 billion, or $122.67 on a per share basis.
As Einhorn goes on to opine in his letter, despite this highly impressive performance, the market barely reacted. It seems no one wants to buy shares in this misunderstood life insurance business.
The only buyer is the company itself. Between May and June, Brighthouse acquired 3% of its outstanding shares.
Management has also been putting their hands in their pockets. Senior managers spent more than $1 million buying stock in the company after the earnings report was released. That's not a huge amount compared to Brighthouse's $4.6 billion market capitalization, but it is a notable development all the same.
Time to buy the stock?
So what should investors make of all these developments?
Well, it is very clear that shares in Brighthouse financial are really cheap. The stock is currently trading at a price to book value of 0.3 and a forward earnings multiple of 4.
That being said, as I have mentioned above, life insurance is a pretty tricky business to understand, and for a company to be successful in the industry, it requires a world-class management team.
There's also the possibility of big swings in earnings because of the large volume of derivative contracts that are required to match assets with liabilities -- something that showed clearly in Brighthouse's third-quarter earnings report.
Whenever Warren Buffett (Trades, Portfolio) invests, he tries to assess the long-term prospects of the underlying business. He wants to know if the company will still be around in 10 or 20 years.
With Brighthouse, I think it is challenging to provide an answer to this question. The company has a duty to remain solvent for its policyholders for the next 10 or 20 years, so we can assume that management is working towards this goal. But what happens if there's a Black Swan event along the way? Brighthouse's shareholder equity could quickly evaporate.
This big unknown and uncertainty means that the company falls firmly into my "too hard" pile. I don't know enough about the life insurance industry to make an informed decision on whether or not the company can stand the test of time. Sometimes, stocks are cheap for a reason, and it is ok not to have a position.
Disclosure: The author owns no share mentioned.
Read more here:
- Buffett: Ignore the Macro, Concentrate on 'What Is Knowable'
- Why Warren Beffett Decided to Enter the Utility Business in 1999
- Learning From Warren Beffett's Mistakes
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
