Elm Ridge’s Financials Trio Returns 170% Over Three Years – At Half The Market’s P/E [2025 Letter]

Elm Ridge’s commentary for the fourth quarter ended December 31, 2025.

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“Graham and Dodd investors are people who place a very high value on having the last laugh. In exchange for the privilege, they have missed out on a lot of laughs in between.” – Michael Lewis, The New New Thing, 2000.

We had a pretty good quarter and an encouraging year. But if you really want to put all your eggs in the all-that has-been-good-will-stay-so-interest-rates-are-coming-down-again-credit-issues-have-not-surfaced-and-will-not basket, you can read this for a few YouTube clips and move on. The S&P has been compounding at about 15% since the end of the 2008 Financial Collapse, the first twelve of those years supported by the Fed and the last three appearing to indicate that we could eventually power through as rates adjusted. The fact that we have consistently run net exposures less than 30% was always going to hurt during this period, as was our value orientation when the Russell 1000 Value Index trailed its growth counterpart by a more than 600 percentage points. Stir in our disastrous early foray into energy and you now have the recipe for WeSuck.

Although Elm Ridge has a long way to go to make up for the 2010s, our dismal decade, we’ve more than held our own since rates bottomed in the summer of 2020. Zigging when the market zags and vice versa, we’ve compounded at 18%, with the 27% rate from the long side (v 17% for the S&P), more than making up for our efforts to short a continued bull market – and despite value stocks continuing to lag.

Green Shoots

“There will be growth in the spring.” – Chauncey Gardner, Being There, 1979

While we’re still waiting for a big, concerted move upward in value, we’ve had enough green shoots to keep us in the game. First, our hard-hit financials: AerCap (AER); Citigroup (C); and OneMain (OMF); began to climb the wall of worry, with an average return of 170% (about 2x the S&P) over the past three years, and yet they still sell at just over half the market’s multiple on the normalized earnings we use for valuation.

Moreover, the three have been big stocks (currently 15% of capital) for us because we were able to balance their vulnerability to a credit downturn with an even bigger short position in some regional banks and life insurance companies. These, we thought, had more risks in their loan and investment books than would have been evidenced during the benign environment supported by interest rate repression. While, to this point, they have avoided large losses, the market is beginning to join our concern and our shorts here have lagged the S&P by about 50% over the same 3-year period.

Meanwhile, a few of our low-priced industrials seem to have awakened as well. Alcoa (AA), GM and Mittal Steel (MT) have shrugged off tariff concerns to return more than 60% on average this past year, with another similar sized move needed to get them to our calculations of fair value.

On the other hand, we must acknowledge that Lyondell (LYB), another stock we pitched in our first quarter letter, with an 8% dividend yield, has tumbled such that it now sports a 13% one. We are now in the middle of the longest and deepest polyethylene (plastics5) down cycle in modern history,6 with about a quarter of world capacity at risk of closure. At current levels, we understand that, even with its low-cost position, the company can barely generate enough cash to support its dividend (although it does have a year’s worth in the bank) and that the analyst community and most professional investors are pushing management to cut it. While they continue to tout the fact that they have increased the payout for 14 straight years, we think that if they did cut, the stock would most likely rise, since professionals would no longer need to worry about being embarrassed (a sin way worse than leaving money on the table). Even some of the skeptics admit that, at this price, LYB could return over 30% annually to shareholders over the cycle.

History Repeating?

The word is about, there’s something evolving,

Whatever may come, the world keeps revolving…

They say the next big thing is here,

That the revolution’s near,

But to me it seems quite clear

That’s it’s all just a little bit of history repeating.

The newspapers shout a new style is growing,

But it don’t know if it’s coming or going,

There is fashion, there is fad

Some is good, some is bad

And the joke rather sad,

That it’s all just a little bit of History repeating. – Propellerheads, 1997

“Lengthy, uninterrupted booms, like the one in the 1920s, produce a collective delusion. Optimism becomes a drug, or a religion, or some combination of both. Propelled along by a culture of hot tips, one-of-a-kind deals, killer sales pitches, and irresistible slogans, people lose their ability to calculate risk and distinguish between good ideas and bad ones.” – Andrew Ross Sorkin

“The only thing new in the world is the history you don’t know.” – Harry Truman

Recent performance is just a sideshow. We’re looking for regime change, as prolonged supranormal returns in credit sensitive assets (growth stocks, debt, housing and “alternatives9”) sew the seeds of its undoing. As Howard Marks argues in a recent memo, “Cockroaches in the Coal Mine”10 (a worthwhile read for anyone interested in investing):

The key observation is that good times lead to complacency, risk tolerance and carelessness, as people bid aggressively for assets and compete to make loans. And then the bad times expose the results of that carelessness, as investments that were entered into without an adequate investigation and margin for error fail to hold up in a hostile environment.

The tidal wave of funds thrown at alternative managers has left a situation where it is now estimated that the “unregulated shadow banking system” controls $70 trillion, with 50% of financial assets touched by unregulated entities – as one observer noted in pointing to the paralleled growth of the trust banks into the Panic of 1907.11 These sums have to bid up asset prices and facilitate more risk. While we acknowledge Marks’ admonition that the recent string of troubling news in credit land (e.g., some high-profile defaults and frauds) need not portend any new systemic problem, we agree that the current starting point should make any investor leery.

So you can ignore the Financial Times (12/30/25) headline “Private equity firms sell assets to themselves at a record rate” (while also selling minority stakes at unprecedented levels.) Don’t worry about the Financial Stability Board and IMF’s concerns about the quality of Private Credit – now comprising more than 1/3 of North American insurance company investment portfolios. While reported loan default rates are still low, S&P now monitors the growing number of “selective defaults” where loans are “cured” by adding interest to the value of the loan (so called Payment-in-Kind, or PIK loans) in lieu of cash payments, with the adjusted default rate now up to 4.6%. So what if the share of private credit loans sporting PIK features, has quadrupled to nearly 20% over the last three years and Goldman Sachs Asset Management estimates that 15% of private credit borrowers aren’t generating enough operating cash to cover interest costs.

We think the supportive landscape for credit and all things risky has helped fuel for the market’s love affair with AI and other growth (e.g. “compounder”) stocks. But the AI story would have engendered excesses all by its lonesome. To quote Marks again:

There’s a consistent history of transformational technologies, generating excessive enthusiasm and investment, resulting in more infrastructure than is needed and asset prices that prove to have been too high. The excesses accelerate the adoption of the technology in a way that wouldn’t occur in their absence. The common word for these excesses is “bubbles.”

One AI start-up just raised a mere $2b at a $10b valuation (and just a couple of months later is looking at a $50b number), and yet the company has not released a product nor told its investors what it is trying to build. Said one investor (who we gather still ponied up some dough) “it was the most absurd pitch meeting, … we’re doing an AI company with the best AI people, but we can’t answer any questions.” We get it. “I could I tell you, but then I’d I have to kill you.” When Nvidia reportedly agreed to spend $20b (or 40x forecasted revenue) for privately held Groq, Sheetal noted that “it’s only $20b.” Of course, that makes Groq worth more than all but 8 names in our long portfolio, including a couple who pay their shareholders more in dividends than Groq has sales.