Book Review: What’s Behind the Numbers?
What’s Behind the Numbers? A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio. 2013. John Del Vecchio, CFA, and Tom Jacobs.
Analysts, equity portfolio managers, students, and even traders will savor What’s Behind the Numbers? A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio. I have already heard that word is getting around graduate business schools and CFA Program study groups about the appeal of this book. What stands out more than any other factor is how current it is. And yet it is classically fundamental in its approach — and immediately useful.
John Del Vecchio and Tom Jacobs have created an examination of conscience for analysts, portfolio managers, risk managers, and investors. Their key point is that there is no shortcut to comprehensive financial and risk analysis complemented by thoughtful technical analysis and market timing. What’s Behind the Numbers? serves as a massive checklist, illustrated with numerous real-life examples and offering analysis that is detailed down to pinpointing the quarter that proves to be the inflection point for a company’s fortunes.
The authors’ combined backgrounds make this unique book possible. Del Vecchio is the co-founder and co-manager of the Active Bear ETF, a fund dedicated to shorting individual stocks with fundamental red flags. Jacobs is the portfolio manager of Motley Fool Special Ops, which focuses on value and special situations. At the outset, they identify the risks associated with investing in stocks — ranging from fads and frauds to aggressive accounting — and set the lofty goal of maximizing wealth and minimizing loss.
The heart of the book demonstrates in numerous ways that there is no substitute for solid fundamental analysis of individual investments. Upon seeing such terms as “DSO” and “EV/EBITDA,” readers may think they are back in a managerial accounting or corporate finance class or have re-enrolled in the CFA Program. Such is not the case, however; What’s Behind the Numbers? uses these basic tools in advanced applications. Del Vecchio and Jacobs delve into cases of dubious valuations, including such household names as (large-cap) Enron Corporation and such overcaffeinated stocks as (small-cap) Green Mountain Coffee Roasters. The authors focus on equities, especially small-cap value stocks, but readers can extrapolate from the examples to analyze corporate fixed income and large-cap equities.
By Chapter 5, “Cash Flow Warnings,” the red flags have been clearly identified. The authors not only pursue extensive balance sheet and income statement analysis line by line and ratio by ratio but also document how the stocks performed in the context of financial and operating deterioration. In addition, they stress the importance of TTM (trailing 12-month) analysis because it facilitates the identification of inflection points in a company’s fortunes. More than any other chapter, “Cash Flow Warnings” emphasizes the experience and decisiveness of the analyst in determining whether the cash flow statement “is real royalty or merely a pretender to the throne.”
Some readers may find Chapter 6, “The Long Strategy That Works for Our Long–Short Portfolio,” paradoxical. Discussing small-cap value and inefficient pricing in the context of long–short investing makes sense, however, considering the authors’ experience with less widely followed names. Many investors shy away from these stocks because it is difficult to accumulate a meaningful position in them, with some capitalizations amounting to less than $100 million. That is exactly the authors’ point. The difficulty of accumulation limits news reporting and analytical coverage, giving rise to hidden value. It also inhibits traders’ ability to create volatility by racing in and out.
The authors consider Chapter 7, “Stock Charts: Know When to Hold ’Em, and Know When to Fold ’Em,” the most controversial chapter in the book because, as they note, most analysts either enthusiastically embrace technical analysis or reject it altogether. The authors justify its use by showing how it improves not only the timing of establishing positions but also portfolio-wide risk management.
Analyzing supply and demand for shares tells an investor a great deal about a position. Turnover in the stock is also revealing. It differentiates between a good company and a good stock; the authors use Microsoft as the prime example. Readers will enjoy the discussions of moving averages and will probably apply the technical tests derived from them to their most baffling positions.
As a fundamental analyst, I grew up on the sort of side-by-side analysis presented by Del Vecchio and Jacobs. At Smith Barney, every published fundamental report included a technical analysis. Clients invariably questioned the recommendation when the opinions diverged.
A picture is said to be worth a thousand words. The graph of earnings quality and stock performance in the final chapter upholds that aphorism, acting almost as a colophon. This section also alerts readers to the risks of index investing, given that relatively few stocks dominate a particular index’s performance.
Even though some of the case studies in What’s Behind the Numbers? date back a decade, the intensity and thoroughness of the authors’ methods are fresh and applicable to any investment situation, not merely small-cap value. This work will be a sought-after reference book among investment managers and analysts for years to come.
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