Del Vecchio cites 3D Systems as an example of a company meriting a bad grade. 3D Systems has captivated investor interest with a stunning 450 percent gain since the start of 2012. But Del Vecchio thinks the company will eventually burn investors, noting that the maker of rapid prototyping machines “gets an F for almost every category we use.”
He’s concerned the company’s accounts receivables are rising at a very fast pace and that the stock trades for more than 10 times trailing revenue. “So management is under pressure to keep meeting the numbers,” Del Vecchio says. He adds that operating cash flow is well below net income and the company’s cash conversion cycle exceeds 100 days.
Specialty Methodology
The FLAG fund aims to reduce investment risk in equities and outperform the market by avoiding accounting blow-ups that can hurt a portfolio.
The ETF has performed well in its brief existence, with a gain of 17 percent since its launch on January 31, or roughly three percentage points more than the S&P 500 during that period. The fund’s expense ratio is 0.85 percent. Its recent top five holdings were Best Buy, Goodyear, U.S. Steel, Cliffs Natural Resources and Raytheon, according to Morningstar.
Del Vecchio back-tested the results for his index and found it would have delivered a 303 percent return from 2000 through 2012, versus a 50 percent gain for the S&P 500.
FLAG has attracted $7.4 million in assets, but remains lightly traded. Garrett Stevens, CEO of Exchange Traded Concepts, the fund’s investment advisor, says the fund tracks an index based on a specialty methodology that has to prove itself in the market.
“Investors will watch the fund’s performance, and will start buying when they see evidence that it works,” Stevens says, adding that this type of specialty fund will likely see slower growth than a fund that tracks an index based on a more traditional methodology.
Regardless of whether you find appeal in this ETF, it always pays to heed the quality of a company’s earnings. In an era of rising stock prices, it’s easy to become complacent and history has shown that such investor complacency can lead to more aggressive accounting policies, some of which can end up in ruinous scandal.