John DVEarnings season is in full swing. Companies have as much pressure as ever to churn out positive reports even if that’s not what’s reflective in the underlying business. And even though the market has had an absolutely abysmal start to the year, many are still saying the S&P 500 will be up about 10% this year, with earnings up 18%.

Is anyone buying this stuff?

With weak economic growth, flat wages, a strong dollar, and consumers stuck in the doldrums, I don’t see much reason to be positive on earnings.

Still, many don’t want to let go of the idea that the bull market could be running out of steam. It’s easier to stick with the herd, and even last year you might’ve made a killing if you invested in some of the glossy tech stories or maybe gun stocks.

But if this is truly a bear market we’re entering, you’re going to be a lot better off capitalizing on the market’s downside. And considering the market hasn’t made any significant moves to the upside for well over a year now, there’s a lot more opportunity on the low end.

As a short seller, I bet against stocks, and I’ve been doing it since 2000 starting with the Internet bubble bursting. Later on I started my second fund to capitalize on the financial crisis in 2007, after which I converted it into an ETF with AdvisorShares that I still manage.

The first thing you have to understand is that most stocks underperform the market. A lot of people on the long side want to sell you on the idea that, over the long term, buy-and-hold is good for your portfolio.

The opposite is true. Fact is, most companies actually underperform the market over time.

75% lost money. 50% were flat to down slightly. 20% were down by 75% or more. And just 25% drove all of the market’s returns.

Consider that from 1983 to 2007 – the largest secular bull market of our lifetimes – among all the stocks in the Russell 3000…

About 75% lost money…

50% were flat to slight down…

20% were down by 75% or more

And only a quarter of stocks accounted for all of the market’s gains.

So nobody should think that you can just buy a bunch of companies and expect to come out on top. In fact, only one company has been in the Dow since the beginning – General Electric. So if you invested in all the individual Dow companies, you’d pretty much be broke at this point.

That said, there’s a lot of opportunity to hedge your portfolio through finding select short ideas. After all, there are a lot more losers in capitalism than there are winners.

For every company that you own in your portfolio, you need to do a quarterly check-up on that company.

If you’re not reading their quarterly earnings reports, you’re at a major disadvantage. All the big hedge fund managers that control billions of dollars have staffs that do this. That’s who you’re competing against when you own stocks.

So you need to do this quarterly check-up on your companies and figure out if things have changed fundamentally or in the financial statements that indicate that the earnings that they’re reporting are not as good on a sustainable basis as what they’re reporting to Wall Street.

Truth be told, there are plenty of line items that management can manipulate to report whatever earnings they want. And there are plenty of sophisticated accounting techniques they can use to make a stock seem better than it really is.

So as a short seller, my job is to find things that management is manipulating that investors really care about… because that’s what’s going to move the stock price.

Right now, the stock market is full of companies that have taken on millions if not billions in debt while their core business is imploding.

Check to see if you’re holding any of those companies by actually reading your companies’ earnings statements.

Everyone knows you can make money when the market goes up. But you can also make a heck of a lot of money when the market goes down.

John Del Vecchio
Editor, Forensic Investor 

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John Del Vecchio
In 2007, John Del Vecchio managed a short only portfolio for Ranger Alternatives, L.P. which was later converted into the AdvisorShares Ranger Equity Bear ETF in 2011. Mr. Del Vecchio also launched an earnings quality index used for the Forensic Accounting ETF. He is the co-author of What's Behind the Numbers? A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio. Previously, he worked for renowned forensic accountant Dr. Howard Schilit, as well as short seller David Tice.