What's Behind the Numbers?: A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio


Learn how to detect corporate sleight of hand—and gain the upper hand with smart investing

Companies are under more pressure than ever to “beat by a penny,” but you don’t need to be a forensic accountant to uncover where the spin ends and the truth begins. With the help of a powerhouse team of authors, you can avoid losing a chunk of your portfolio when the next overhyped growth stock fails by knowing What’s Behind the Numbers?

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What's Behind the Numbers?: A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio

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Learn how to detect corporate sleight of hand—and gain the upper hand with smart investing

Companies are under more pressure than ever to “beat by a penny,” but you don’t need to be a forensic accountant to uncover where the spin ends and the truth begins. With the help of a powerhouse team of authors, you can avoid losing a chunk of your portfolio when the next overhyped growth stock fails by knowing What’s Behind the Numbers?

Investing experts John Del Vecchio and Tom Jacobs mix a potent combination of earnings quality analysis, long-side investing, and short-side portfolio risk management to help you create a long-short portfolio with less volatility and greater returns, while avoiding landmine stocks that will blow a hole in your financial security.

First, the authors explain the practical side of financial analysis. They demystify widely held assumptions about stock performance, expected returns, earnings quality, and short sellers. Then they comb the financial statements to find the places where companies hide poor earnings quality. Finally, they provide the value and special situations investing to pair with the short-side thinking and offer a tactical manual for applying what you’ve learned in the technical, day-to-day world of portfolio management.

Armed with this wealth-saving guide, you can confidently trade based on clear data—not the aggressive accounting tactics companies use to make their numbers look better than they are. Better still, it helps you start protecting yourself right away with:

  • Rules for finding companies playing with—rather than by—the numbers
  • Repeatable methods for uncovering what companies don’t tell you about their numbers
  • Multistep approach to deciding when to sell a stock and when to short sell it
  • Reliable formulas for determining when a stock will get hit

The next time a company goes south, you can be the successful investor who knew What’s Behind the Numbers?

Praise for What's Behind the Numbers?

“At Crazy Eddie, we succeeded in perpetrating our financial fraud for many years because most Wall Street analysts and investors took for granted the integrity of our reported numbers. What’s Behind the Numbers? teaches investors to critically look under the surface and spot red flags that could help them avoid potential losses from fraudulent companies like Crazy Eddie.”
—Sam E. Antar, former Crazy Eddie CFO and convicted felon

“I know of no other book that better teaches the reader how to determine earnings quality at a company, so you can avoid large losses on stocks you would otherwise own, and score profits by going short. Not only that, this book teaches you how to grow wealth with small-cap stocks in a way that would make value deity Ben Graham proud. . . . Essential for any investor.”
—Jeff Fischer, Portfolio Manager, Motley Fool Pro and Motley Fool Options

“Under [Del Vecchio and Jacobs’s] tutelage, forensic accounting is reduced to Math 101. We learn how to employ the metrics they use to expose fi nancial chicanery in companies, to unearth the best short sales, and to protect ourselves from owning those stocks most likely to blow up and wreak havoc on your portfolio. Read What’s Behind the Numbers? so you can keep your portfolio clear of ticking stock bombs.
—Jeffrey A. Hirsch, Chief Market Strategist, Magnet Æ Fund, and Editor-in-Chief, Stock & Commodity Trader’s Almanacs

“Wow! A must-read for anyone who thinks they know how to make money in the stock markets! Del Vecchio and Jacobs forced me to confront the stark reality of What’s Behind the Numbers? It isn’t pretty. . . . One of the best books on investing I have read in years.”
—Tom Meredith, former Chief Financial Officer of Dell Inc., venture capitalist

“This work will be a sought-after reference book among investment managers and analysts for years to come.”
—Janet J. Mangano, CFA Institute’s Financial Analysts Journal

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Editorial Reviews

"[An] informative book . . . . Written in lively prose."
“[An] informative book . . . . Written in lively prose.”
Kirkus Reviews
Densely structured handbook, full of subheads and tables and big numbers, on how to structure a portfolio. You've got to hand it to the publisher for chutzpah: Sam Antar, the former Crazy Eddie CFO and convicted felon, endorses this book as a guide to the financial fraud that Wall Street perpetrates daily. And not just fraud: The numbers in the financial world are so big and so fluid that it often seems that even the talking heads on the business channels don't understand what they mean. Consider overvalued companies, bid up far beyond their worth through the magic of the machine. Write fund manager Del Vecchio and Motley Fool veteran Jacobs, it's important to "identify these companies by looking for a high price-to-sales ratio, specifically one in the highest decile." Fair enough, but what constitutes a high ratio, and why look at the highest decile? The authors explain, and well, but in language that is necessarily daunting and that presumes some serious dedication on the part of readers, who are likely coming to this book in the hope of making money. That can be done, the authors write, but through the practice of some fundamentals, including one that is so often overlooked in a culture of churn--namely, lose less, make more. Del Vecchio and Jacobs look sideways and decidedly askance at supposed hedges such as gold, mostly because it "really has been worth only what people say it is," and locked-up assets ("I prefer hard assets in use rather than in storage"). The overriding message is study, study and study the numbers some more but always with this understanding: "Every financial statement offers the opportunity for manipulation, because they all interrelate." A highly useful companion to making financial decisions, though not for the innumerate or the casual investor.
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Product Details

  • ISBN-13: 9780071791977
  • Publisher: McGraw-Hill Professional Publishing
  • Publication date: 10/12/2012
  • Edition number: 1
  • Pages: 256
  • Sales rank: 146,926
  • Product dimensions: 6.20 (w) x 9.10 (h) x 3.70 (d)

Meet the Author

John Del Vecchio is the cofounder and co-manager of The Active Bear ETF, a fund dedicated to shorting individual stocks with fundamental red flags. Previously, he managed a hedge fund for Ranger Alternative Management, L.P. In addition, he worked for well-known short seller David Tice and famed forensic accountant Dr. Howard Schilit. Del Vecchio coadvises the Motley Fool Alpha long-short newsletter.

Tom Jacobs, Portfolio Manager of Motley Fool Special Ops, applies this book’s earnings quality tests to his value and special situations long side to form a long-short portfolio. He is managing partner of holding company Complete Growth Investor, LLC, principal of The Marfa Group, Inc., and a real estate investor.

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Read an Excerpt

What's Behind the Numbers?

A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio

By John Del Vecchio, Tom Jacobs

The McGraw-Hill Companies, Inc.

Copyright © 2013John Del Vecchio and Tom Jacobs
All rights reserved.
ISBN: 978-0-07-179197-7



The Real Risk of Stock Investing

Most stocks lose money. That's right, so forget about the financial services industry's mantra to buy stocks and hold them forever. Ignore the moment-by-moment media anxiety—Dow up! S&P 500 down!—that plays to the emotions of fear and greed to grab your eyes, ears, and money. Instead, stay calm and look at the data, not the marketing.

Consider the longest secular bull market most people today have ever experienced, 1983 through 2007. Blackstar Funds studied all common stocks that traded on the NYSE, AMEX, and Nasdaq during this period, including those delisted. They then limited their research universe to the 8,054 stocks that would have qualified for the Russell 3000 at some point from 1983 through 2007. During this period the Russell 3000, accounting for 98 percent of U.S. stock liquidity, rose nearly 900 percent, yet:

* 39 percent of stocks had a negative total return. (Two out of every five stocks are money-losing investments.)

* 18.5 percent of stocks lost at least 75 percent of their value. (Nearly one out of every five stocks is a really bad investment.)

* 64 percent of stocks underperformed the Russell 3000. (Most stocks can't keep up with a diversified index.)

* A small minority of stocks significantly outperformed their peers.

Blackstar provides the stark reality supporting the last point: The best- performing 2,000 stocks—25 percent—accounted for all the gains. The worst performing 6,000—75 percent—collectively had a total return of 0 percent.

It's obvious that a few stocks are responsible for all the market's gains. This shows why it is essential to avoid the losers—and that there are valuable opportunities to profit from shorting, even in a bull market. But the long-only investor has it far worse: To garner real returns, that investor has to be extraordinarily lucky to pick only the outperformers and none of the portfolio-destroying disasters. The odds don't favor this.

Imagine you are reading this in 1979 and we told you that General Motors, Woolworth's, and Eastman Kodak—strong and undoubted Dow components—would in 33 years all be bankrupt. You would never have believed us, yet it's all happened. Large brand-name stocks give the illusion of stability, but there is none. They join the index long after their periods of greatest growth, when their size guarantees a future of GDP growth at best. What are the odds you would have picked only the survivors, let alone the winners?

But let's assume for a moment that you possessed the extraordinary good fortune to pick only the 25 percent winners in the Russell 3000. You probably still don't win. Human nature can't take the pressure of the roller-coaster ride.

Consider Ken Heebner, whose results at Loomis-Sayles Peter Lynch called "remarkable." Heebner opened his own mutual fund business, and on March 25, 2010, his CGM Focus Fund had racked up annualized returns of more than 18 percent since January 2000. That's starting before the 2000–2002 crash and including 2008. These returns are unbelievable, but what happened? Investors behaved like ... people. They poured money in after his 80 percent return in 2007, just in time for the fund's 48 percent drop in 2008. Morningstar modeled the fund's cash inflows and outflows to find that the typical investor actually lost 11 percent per year, despite CGM's 18 percent annualized gains, selling during downturns in CGM's performance and buying at upturns.

Instead of buying more during or after Heebner's or any other great investor's disastrous periods such as calendar year 2008, investors sell. Heebner's contrarian success comes with great volatility that most can't handle. Investors chase last year's winner, buying high and selling low.

If most stocks lose money and most investors' emotions get in the way of profits, why invest in stocks at all?

Inflation Kills

The conventional wisdom for investing in the stock market is to grow savings beyond the rate of inflation. While experienced investors understand the concepts of nominal (the actual number) returns and real (the number minus inflation), most investors do not make this distinction. They are happy when their stocks are up nominally and unhappy when down nominally, even though inflation and deflation make the numbers irrelevant to what that investor has actually gained or lost. Real—inflation adjusted—returns are all that matter.

The conventional wisdom is right, because inflation does destroy the purchasing power of paper money. Unfortunately, whether the stock market provides the real returns to mitigate or eliminate that threat depends on when you happen to live. Average annual real returns may or may not be positive and, even if positive, may not be for long periods. Beating inflation is likely an accident of birth. Examine Table 1.1 of the S&P 500, including dividends, from 1950 to 2009.

The 1950s skew the results dramatically. That decade produced the lowest annual inflation of all. Figure 1.1 shows the table information starkly and emphasizes the flat nominal returns from 1968 to 1983 and devastating real returns. Then, the 1980s and 1990s produced truly excellent annual real returns, followed by poor ones.

The data require more analysis. Unless an investor dollar-cost averages (invests roughly equal sums at regular periods) in the S&P 500 with these dividend yields, that investor risks choosing the majority of stocks that do not produce the S&P's average and/or have lower or no yield, reducing or eliminating the benefit of reinvesting dividends. Remember, most gains in the stock market averages come from a minority of stocks.

Problems with Dollar-Cost Averaging

But even dollar-cost averaging is no panacea, because incomes and savings increase with age, and age reduces the time available for compounding. It is completely random whether a person's high-wage-earning years and greater investing returns occur during high or low inflation and therefore times of high or low real returns. During tough economic times, income and savings may not increase with age.

And human nature also puts the kibosh on dollar-cost averaging. Benjamin Graham and David Dodd notably described the simple problem, captured by Jason Zweig:

Asked if dollar-cost averaging could ensure long-term success, Mr. Graham wrote in 1962: "Such a policy will pay off ultimately, regardless of when it is begun, provided that it is adhered to conscientiously and courageously under all intervening conditions." For that to be true, however, the dollar-cost averaging investor must "be a different sort of person from the rest of us ... not subject to the alternations of exhilaration and deep gloom that have accompanied the gyrations of the stock market for generations past."

"This," Mr. Graham concluded, "I greatly doubt."

Graham didn't mean that no one can resist being swept up in the gyrating emotions of the crowd. He meant that few could. To be an intelligent investor, you must cultivate what Graham called "firmness of character"—the ability to keep your own emotional counsel. Otherwise, you risk ending up like Morningstar's estimate of the average investor losing money in Heebner's super- performing CGM Focus Fund, buying high and selling low.

To preserve the purchasing power of your money against inflation and grow it at a higher rate, you must invest early, with discipline, and for a long time or earn multiples of your wages later to make up for the shorter time period availabl

Excerpted from What's Behind the Numbers? by John Del Vecchio, Tom Jacobs. Copyright © 2013 by John Del Vecchio and Tom Jacobs. Excerpted by permission of The McGraw-Hill Companies, Inc..
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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Table of Contents

Acknowledgments vii

Introduction: What This Book Does for You 1

Part 1 Expose the Chicanery

1 The Real Risk of Stock Investing 9

2 Aggressive Revenue Recognition 35

3 Aggressive Inventory Management 63

4 More Unsustainable Boosts to Earnings 83

5 Cash Flow Warnings 123

Part 2 Avoid Huge Losses

6 The Long Strategy That Works for Our Long-Short Portfolio 173

7 Stock Charts: Know When to Hold 'Em and Know When to Fold 'Em 199

8 Market Timing 219

9 Why This Works: The Numbers Behind the Numbers 243

Notes 255

Index 267

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