John Del Vecchio really is a nice guy, I promise.
But he doesn’t smile a lot.
Maybe it’s because he grew up in upstate New York, where you can go weeks in winter without seeing the sun… or maybe it comes from the years he spent working as a forensic accountant and as a professional short seller.
But John definitely has a serious, no-nonsense demeanor about him.
And let me tell you from experience, you don’t want to be on the opposite side of a trade as him.
This seems almost ridiculous now, given the company’s dismal performance, but many moons ago I was bullish on International Business Machines (NYSE: IBM). The stock looked cheap on paper and paid a high and growing dividend. And, perhaps best of all, the legendary Warren Buffett had recently taken a large stake in the company. It looked like a can’t-lose investment.
Until I mentioned it to John…
John spent a good 20 minutes dissecting my investment thesis point by point… until there was nothing left.
“They’re cooking their books, Charles,” John told me bluntly. “And there’s no cash flow to support all those dividend hikes.”
I feebly protested, mumbling something about recurring revenue streams and long-term service contracts, before John raised his hand to silence me.
“Sure, they’re growing their earnings per share, but there is no actual cash flow to support it,” he said. “They’re borrowing money and using it to reduce their shares outstanding. It’s financial engineering… and one of the oldest tricks in the book.”
He paused for effect.
“You have to follow the money, Charles.”
John walked me through the numbers, and I had no choice but to acknowledge he was right. And it’s good that I did, because IBM is down by about a third since we had that conversation.
In the end, it was Amazon.com that killed IBM.
Amazon’s cloud platform, AWS, was vastly cheaper and more practical than IBM’s traditional business services. It was only a matter of time until Amazon knocked IBM off its pedestal.
In retrospect, it seems so obvious that IBM was about to get obliterated by Amazon. But none of us – not even Warren Buffett – saw it coming.
At the time John warned me to steer clear of IBM, he knew next to nothing about Amazon’s AWS or the competitive challenge it faced for IBM.
But by digging into the numbers as he does as Dent Research’s in-house forensic accountant, he could tell that the company was in trouble and that it was using aggressive accounting to cover it up.
Something was wrong. The “why” wouldn’t be obvious for another few years, but by then it would be too late for the IBM bulls.
John has spent most of his career hunting down companies using aggressive accounting to bamboozle their investors. And he’s good at it, or he wouldn’t have survived this long as a professional short seller.
But here’s where it gets fun.
The same tools that can be used to identify bad companies with low-quality earnings can be turned around to find good companies with high-quality earnings.
And, as you know, that’s exactly what John does in Hidden Profits.
He uses six handpicked factors for scoring and ranking stocks: cash flow quality, revenue recognition, earnings quality, shareholder yield, earnings surprise, and valuation.
In plain English, he’s looking for underpriced companies with good management and honest bookkeeping. These are profitable gems, hiding in plain sight.
Companies that use aggressive accounting tactics to puff up their earnings eventually have to face the music. At some point, they run out of tricks and have to come clean. And when they do, it catches most investors by surprise and leads to a bloodbath in the stock price.
But companies using clean, conservative accounting are a lot more likely to surprise with better-than-expected earnings.
Just as John was able to detect the risks to IBM long before they made the news, he’s also able to find promising companies long before they ever pop on the radar of Wall Street analysts.
Company policy doesn’t allow me to personally own stocks that I recommend to readers. But I can tell you that I have bought many of the stocks John recommends, and I shorted Big Blue.
So here’s some good news for you: On Tuesday, John’s hosting a special video broadcast that highlights several new profit opportunities. It’s free to attend, but you must sign up here. I know I’m not going to miss it.
Editor, Peak Income