A bear to the bone, John Del Vecchio looks for companies hiding dirty, disgusting messes-and then cleans up.
Late in the fall of 2006, John Del Vecchio, an analyst with Dallas-based David W. Tice & Associates, managers of the Prudent Bear Fund, was about to get on a conference call when it hit him: He had written his last research paper.
I should be trading, Del Vecchio thought as the voices, challenging his research on a stock, came out of the squawk box. “I knew my research was dead-on,” he recalls. “I just had this moment of clarity. I was tired of arguing my points. I realized I should be trading these names myself.”
Del Vecchio’s ideas made money. He began to paper-trade them using strict money-management rules while he contemplated finding a trading opportunity in which he could have discretionary control over his ideas, and his income.
In June 2007, he departed from Tice’s firm to join Ranger Capital Group, a Dallas-based company that runs a hedge fund called Ranger Alternative Management. Ranger manages more than $1.3 billion; Del Vecchio oversees the fund’s short-only portfolio, taking on as many as 30 positions at a time. While he wouldn’t break out how his portfolio has done or how large it is, he appears to have done his part to help Ranger Alternative to a 24 percent return this year through August.
Del Vecchio, 32, now puts his convictions into action, not white papers. He walks into his eleventh-floor office in downtown Dallas every day looking for someone to bet against. A traditional short seller, he abides by a simple theory: If there’s robust demand for a company’s products, management has no reason to engage in accounting gimmicks that mask operational deterioration. “I can see where the companies are utilizing some aggressive accounting or understating inventory. If they’re a one-product company, they’re going to have risk if the bottom falls out of their market,” he says. “But since we’re all looking at the same numbers, it’s going to come down to putting on the trade and having the conviction. Not that everyone is a crook, but we all know that executives try to support their stock as long as they can.”
Del Vecchio, who focuses on small- and mid-cap names, generally looks for evidence of low earnings quality and aggressive accounting. With that, though, he is acutely aware that small- and mid-cap names can get terribly thin if they go against you. He doesn’t sleep with one foot on the floor, because he uses stops to protect his capital; he also avoids shorts that draw crowds.
In one such trade last fall, he went short IMS Health Inc., a provider of market intelligence to the pharmaceutical and health-care industries, because his fundamental criteria were met. He sold it short when it was trading in the low 30s. Then the news hit the tape: “Days sales outstanding” (DSO) had jumped five days in June, and deferred revenue fell $6.5 million. DSO jumped 10 days in September.
Del Vecchio’s decision to short was based on his understanding that an increase in DSO is indicative of extended payment terms. That trend would accelerate into autumn. Also, the deferment put pressure on IMS’s ability to meet future targets as well. Look out below! In the end, Del Vecchio covered, for a 25 percent gain.
Short selling, clearly, is only for traders with steely constitutions. Those who know Del Vecchio aren’t surprised he has the requisite makeup.
“His greatest strength is understanding why a particular name or company makes for a timely investment,” says Craig Sheets, a principal/analyst with Wilmington, Delaware–based Assay Research. “He’s seemingly able to differentiate noise from real issues when names go against him — another trait of successful investment managers.” One of Del Vecchio’s favorite noises while attending Bryant College in Smithfield, Rhode Island, was the sound of horse hooves thundering down the stretch at nearby Lincoln Park. The Syracuse, New York, native always made time for between-class trips to the track, two miles from campus, and unlike a lot of young kids, he didn’t let the gambling bug drag him down — he maintained a 4.0 GPA and won more on wagers than he lost. More importantly, he became fascinated with odds and the wisdom of crowds. He graduated in 1998 with a degree in finance, and by 25 had earned his CFA.
Parimutuel wagering interested him because he believes that people systematically under- and overestimate the odds of something happening — in this case, a horse winning a race. “This led to my interest in stocks, since the market is bigger, but the concept is the same — with better odds,” he says.
His interest in shorting stocks began in 2000, when he was working for an Internet company (which he chooses not to name) that had solid backing and a good brand. However, a look at his employer’s revenue model and financials, along with the knowledge of how the VCs wanted to burn through company cash, indicated to him that disaster loomed for the entire dot-com sector. His instincts proved spot-on.
“Most CFAs are too literal and not dynamic enough, but John has a grasp of the intangibles,” says John Sidawi, vice president and senior trader at Federated Investment Management in Pittsburgh, and a longtime colleague. “We all share the same information content; John has the ability to translate it into performance.”
In 2001, Del Vecchio landed a job at Rockville, Maryland–based CFRA, Inc., working as one of a team of forensic accountants. The group had an enviable track record of uncovering lousy stocks that then plummeted. “At CFRA I took away two key concepts,” he says. “First, every company is guilty until proven innocent. In other words, let the numbers and the nuance of the SEC filings, not management, tell you if business is good or not. Second, the higher up on the income statement a concern is, the more critical it is.” Del Vecchio went to work for David Tice in late 2002, honing his skills alongside one of the most famous bears alive. “I realized during my stint there that if I stick to accounting issues, I can find shorts that work even in a bull market,” he says. “Where I lost, almost all of the time, is when I strayed from this and wrote research on fundamental issues such as the health of the advertising market or iPods.”
At Ranger, a firm with broad infrastructure and support, Del Vecchio now has another opportunity to put his theories about aggressive accounting and risk management to the test. One short over the past year and a half that he liked — but which failed to pan out — was Stanley Inc. “When it reported improved backlog, I exited the position as the concerns regarding unbilled A/R abated,” he explains. “We got out at a small loss rather than trying to hold and hope things went our way.” “There are always timing mistakes,” he adds. “My biggest mistakes happen when I fail to recognize that the issues I’ve identified as being problems are no longer relevant. To be a winner as a short, you have to be a great loser.”
This article originally appeared in the October, 2008 edition of Trader Monthly.
John Del Vecchio wrote a guest spot on Marc Faber on MartinKronicle.