What’s Behind The Numbers: A Chat With John Del Vecchio

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John Del Vecchio, manager of Active Bear ETF, discusses his new book, “What’s Behind The Numbers.”

John Nyaradi: Hi, everyone. I’m John Nyaradi, Publisher of Wall Street Sector Selector, a financial media site specializing in exchange traded funds and global markets, and today I’m really pleased to welcome our special guest, John Del Vecchio. John, welcome to Wall Street Sector Selector.

John Del Vecchio: Thanks for having me back, John.

John Nyaradi: Great to have you here, John, like always. Whenever I talk to you, I always learn a lot.  John Del Vecchio is the co-founder and co-manager of the Active Bear ETF. That’s symbol HDGE. Active Bear (NYSEARCA:HDGE) is an ETF dedicated to shorting individual stocks that have fundamental red flags around them. Previously, John was a hedge fund manager for Ranger Alternative Management.

He co-advises a delvecchio cover Whats Behind The Numbers: A Chat With John Del Vecchionewsletter for Motley Fool and is a chartered financial analyst. Today we’re going to talk about John’s new book, What’s Behind the Numbers?: A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio.  It has been well received and has been named Best Investment Book of 2013 by Stock Trader’s Almanac.

So let’s start at the top, John, why did you write the book and what can people expect to get out of it?

John Del Vecchio: We wrote the book in order to help people avoid a big loss in their portfolio. So even though I’m a short seller and I trade, it’s not really a book about short selling. It gives investors tools to identify companies that they may own that are showing red flags that could be a sign of trouble ahead.

Our view is that avoiding a big loss is really more important than generating a large gain. If you lose 50% of your net worth, for instance, you have to gain 100% just to get back even and we feel like anybody, whether it’s a do-it-yourself investor or a more sophisticated professional asset allocator, would do well to learn tools and techniques that will allow them to avoid large losses in their portfolio and that’s what we do within the context of the book.

John Nyaradi: Part One talks about the real risk of stock investing.  What is the real risk?

John Del Vecchio:  Most stocks are actually losers over time. So imagine we were talking in 1970′s and we were talking about Eastman Kodak and Polaroid and General Motors. Those were widows and orphan stocks back then and now fast forward the clock 30 years and they’re all dead money. Then in the 1990s, we had Intel, Microsoft, Dell, Cisco, those were the four horsemen of the internet. They’ve now been essentially dead delvecchio pix Whats Behind The Numbers: A Chat With John Del Vecchiomoney for the last 12, 13, 14 years. So the winners from one generation are generally not the winners of the next and in capitalism, in general, you can’t have a lot of winners. For every Wal-Mart, you’ve got 40 regional retailers that don’t exist anymore because Wal-Mart beat them in terms of distribution, technology, pricing, whatever the case may be.

So picking an individual stock is a risky endeavor because you’re betting on your ability to identify that one company that’s going to be a massive success within a sector or in that particular cycle of the market. So that’s where it’s very dangerous.

It’s also very dangerous in that it depends on really the 20 to 30-year time frame in which you are generating your highest income and your highest savings.  If you were investing from 1968 to 1982, chances are you didn’t make any money and you probably lost about 70% in real terms just because of inflation.  If you were investing during the bull market from ’82 to 2000, you probably did pretty well. But the last ten or twelve years haven’t been that great.

So while people talk about stocks for the long run, often they’re taking about 100 or 200-year time frames. I don’t plan on living 200 years so the twenty years in which I’m generating my highest income and savings are the most important for me in terms of securing my future.

And the odds are just against you for being able to identify the companies that are going to be the next Google or Apple.  So we talk about certain warning signs that ultimately will be reflected in a lower stock price.  We walk through income statements, balance sheets, cash flow to help you spot these trouble signs before they occur. And I think the best thing about the book is that these are real time case studies that were written and published in real time and then show you what occurred, you know, 6 months to 2-years after we had identified these things before the stock actually blew up.

John Nyaradi: You talk about two common investing themes, dollar cost averaging and buy and hold, and it sounds like you don’t endorse either of those too much.

John Del Vecchio: No, the problem with dollar cost averaging an individual stock really comes from Bill Miller, the famous mutual fund manager from Legg Mason. His mantra was “Lowest average cost wins.”

And so when stocks go against you, you buy more. The problem is when you own Enron, AIG, Fannie Mae, Freddie Mac, WorldCom, all these companies that were basically bankrupt, and he owned them all, it destroys your performance.  So dollar cost averaging during a massive meltdown in the market is essentially putting good money after bad, in our view. Conversely, Paul Tudor Jones is probably the greatest trader of our lifetime and he says that the market tells you fairly quickly if you’re right or wrong and so don’t average losses but actually build on your winning positions.

John Nyaradi:  Part 2 of your book is titled “Avoid Huge Losses.”  How do you do that?

John Del Vecchio: From a long perspective, we want to be value investors.  We want to buy a dollar’s worth of an asset for fifty cents that has a catalyst that we can foresee that’s going to allow that value to be realized. Maybe it’s the sale of an asset or the realization that the asset is worth more than it’s being carried for on the books.  We also show there’s real value in having a long/short portfolio that can offer a smoother overall return.

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