I recently came across an old transcript of a David Einhorn speech at the Value Investing Congress
in 2006. In case you didn’t know, Einhorn is not only a famous hedge fund manager, but a big-time poker player as well. In the speech, Einhorn speaks of his experience at the World Series of Poker and how his poker traits are very similar to his methods as an investor.
In the speech Einhorn also reveals a few tricks that some hedge funds use in finding long and short candidates. Here’s the quote from Einhorn that caught my attention:
I recently met a smart hedge fund manager who has built a $10 billion fund around screening for companies with high ROEs and low P/E multiples for longs and low ROEs and high P/E multiples for shorts. The manager adds human analytical effort to confirm that the screened results are not anomalous accounting figures but instead generally confirm the performance of the business. This has been a successful approach.
It’s such a simple approach, yet sometimes simple screens such as this can lead to the most profitable ideas. Screening based on fundamentals alone is somewhat useless without human intervention to scrub the data. But I like the idea of screening on High PEs and Low ROEs. So, I figured it was worthy enough to at least take a look.
I set up a screen on Finviz
seeking companies with a negative Return on Equity (ROE), a forward P/E greater than 20, short interest as percentage of float greater than 5%, price greater than $10/share and average daily trading volume of greater than 50K. I use the 5% threshold on short interest, since it indicates to me that others are probably identifying some flaws with the company. And in my opinion, it’s the short sellers who do the most fundamental work of all investors.
To note, in the Einhorn speech, he advises against using ROEs to measure non-capital intensive businesses such as software or consulting firms who rely on their intellectual property or human resources to derive future revenues. Therefore I would avoid any non-capital intensive companies and focus on those who are reliant on capital to grow their business -- companies where “growth requires another plant, a distribution center, a retail outlet or simply capital to fund growing accounts receivable or inventory.”
Feel free to check out the screen and do some of your own digging. A few that might be interesting include the following:
(NYSE:SKX) – Forward P/E=21x, ROE=-6%, Short Interest as %Float =11.6%
(NASDAQ:TSLA) – Forward P/E=77x, ROE =-177%, Short Interest as %Float=43%
(NASDAQ:VSAT) – Forward P/E=27x, ROE=-1%, Short Interest as %Float =22%
No positions in stocks mentioned.