Indexing is essential. Using forensic accounting screens makes it even better, Ranger’s John Del Vecchio says.
John Del Vecchio, forensic accountant and co-portfolio manager of the Ranger Equity Bear ETF (NYSEArca: HDGE), has a new book out that puts indexing in a favorable light, but with a few important twists.
Del Vecchio told IndexUniverse.com Correspondent Cinthia Murphy that owning swaths of the market is the only way to preserve returns in a world full of vagaries that can torpedo the most established of companies. But that doesn’t mean he buys into traditional market-capitalization-weighted methodologies.
After all, Del Vecchio helped create the Earnings Quality Index that will underlie a forensic accounting ETF that went into registration last month. He discusses the key concepts behind that fund in his book “What’s Behind The Numbers?”, arguing that applying forensic accounting and focusing on earnings quality allows him to find value stocks while excluding accidents that are waiting to happen.
Murphy: Right off the bat in your book you make the argument that most stocks will lose money even in a bull market. If that’s the case, stock-picking is a losing proposition any way you slice it. It sounds to me like a big pro-indexing statement.
Del Vecchio: That’s fair. For a buy-and-holder or a dollar-cost-average investor, the only way to really invest is to do it in the index space, and not through individual securities. To make this statement more realistic, imagine we were talking in the late 1970s; we would be talking about Kodak, Polaroid and General Motors, companies that back then were stars, but 30 years later were all bankrupt. Fast-forward to the 1990s, and the same can be said about Microsoft, Intel or even Cisco. Today you have Apple and Google. The reality is that from one generation to the next, in the stock market, the leaders don’t carry over. The only way to get sustainable returns is to own an index.
Murphy: I can’t help but to link this to the argument Rob Arnott recently made about the problems with chasing big companies. There’s no such thing as a safe bet, as in a too-big-to-fail stock that investors should own, right?
Del Vecchio: Think about it this way: Enron was an $80 billion company when it spiraled downward and into bankruptcy eventually. There are many others like it. The market capitalization or even the revenues of a company have really nothing to do with what’s going to happen in the future. Every company experiences a bump in the road; there’s no company that’s going to have just a clear straight trajectory of growth. But how the company withstands the bump in the road will have a lot to do with its management, and with its ability to sell its product. At the end of the day, a company’s earnings quality is the most crucial metric here.