First, let’s calibrate ourselves. Generally speaking, over the last 100+ years, the markets as a whole never get below a P/E of 5. Recently, I have found myself wondering, why on earth am I buying a company with a P/E ratio of 4 or less that is growing 10x faster than the markets ever have? Over the last year or so, I have applied this investment hypothesis of buying what I perceive to be undervalued companies to the test and from a nominal standpoint have done terribly.
There are some expensive lessons that I have learned in the past 12 months. In a nut shell, companies that are growing faster than everything else and performing incredibly well may continue to have low prices and may even get cheaper. Perception is reality. The reality of the situation is that for the most part, people don’t care about Chinese Microcaps. This shall pass.
In the short term:
1. You can lose money buying a company with a P/E of 4 and growth of 30%+.
2. There are people that will (try to) profit from lies and scare tactics.
3. When people don’t care to begin with, the trend is for them to care less if they can.
The consensus: The analysis can be very right, but the timing can be very wrong.
In the long term:
1. You will make obscene profits buying a company with a P/E of 4 and growth of 30%+.
2. Lies and scare tactics are diluted by time and transparency.
3. People are interested in profitable opportunities.
The takeaway: Always be ready for lower prices.
I had no idea that the short run could be 18 months or even longer. I have firmly believed and publically stated that we are in a global bull market since January of 2009. For all of 2009, friends and family all thought I was crazy. I figured I’d catch a ride on the way up by buying the most undervalued companies in the world. I bet that over the last 18 months, US listed Chinese Microcaps would march towards efficiency. As far as I can tell, this has not been the case. They’ve tended to move up and go back to where they’ve started. Great for short term traders and bad for long term investors.
My peak oil hypothesis and the FED’s monetization of the deficit will continue to send nominal prices of everything much higher. That said, right now I think we are just seeing a spike in oil — but this spike will only bolster the confidence in higher oil prices and those that bought into this are likely going to be holding on for a while. Good luck if you think we’ll dip back down as far as we spiked up. I don’t think we’ll ever see oil prices below $80 at this point in time.
Right now, corporations are booking all-time record profits, commodity prices are rising, and things are getting better. It’s a great time to be involved on the long side. That is, unless you have been involved with the most undervalued sector in the world: Chinese Microcaps.
All of this upside — it appears for the most part has passed me by. If I was driving down the highway, it would be as if the lane that I am in is moving in reverse and everyone else is flying by me waving. Does this mean I should switch lanes or pull over to the side of the road at this point in time? I don’t believe so. I think my lane is about to become the fast lane. It’s so bad that there are profitable companies out there right now listed on the NYSE that are selling at less than cash – total liabilities and are in the process of buying back their stock at these depressed prices. Frankly, they can buy back more than their entire market capitalization and pay off their debt and still have “free money” leftover. You better believe that these kinds of prices are not here to stay. There is a certain point that I look for of extreme pessimism that after which I can confidently state that the bottom is in. The only thing I’m really good at is calling bottoms, frankly.
What this sector needs is a leader. This sector needs buybacks. This sector needs dividends. This sector needs certainty in audits. This sector needs institutional investors. This sector needs more transparency. This sector needs mergers and acquisitions. This sector needs a single stock that goes from the bargain bin to performing in line with where its fundamentals would put it. This sector simply needs a shot of confidence. Over the last 18 months, the confidence in this sector might as well be a deflating balloon. Everyone and everything is suspect. For you to confidently invest, the present sentiment is that the company needs 10 independent audits and you personally need to go withdraw their cash to make sure it exists and then redeposit it back into the bank. You also need to question all of their customers and independently verify the legitimacy of all of the payments that go to and from the company. On top of all of this, you need to be rich enough to buy the entire company at the current price, because the market apparently is willing to sell you all of their shares at the current price, and if they don’t have shares to sell you, they’ll sell you them short.
Frankly, I don’t care which company decides to lead the charge out of the dark storm cloud that encompasses the land of Chinese Microcaps. It’s going to happen eventually. I have a feeling that it’s going to happen around the 2 year anniversary of the March 2009 market bottom. I also have a feeling that the company leading the charge is also the innocent victim of a multitude of short pieces recently.
How can I think all of this? Some people structure their mental framework with the axiom that if they buy something and it goes up in price, their investment hypothesis was correct and that if it subsequently goes down in price, they were wrong. I believe that this is incorrect and is simply a confirmation bias — whereas I believe that if you thought it was a good deal to begin with, and nothing about your fundamental investment hypothesis has changed except for the entry price, that the market is simply offering up higher future returns to those that were more patient than you. That said, you must constantly re-evaluate your investment hypothesis as new information enters the picture that makes you question the validity of its various components.
What is happening right now? One instance is a company that is forecasting growth at 30%+, has an earnings multiple of less than 5 and is announcing blowout record earnings. The stock price responds by dropping 50%. Is this rational? Heck no. Was the price rational to begin with? Of course not. If I were to buy and hold this company for 5 years would I outperform the general markets? Of course. That doesn’t even take into account multiple expansion. We’re talking more than 1000% return for the extremely patient.
By the way, in the market I invest in, I have seen absolutely no multiple expansion. I continue to believe that this is a buyers’ market. There is a huge demand for access to capital coming from China and there is practically no one trading in the US markets that wants to own these companies. I have many friends that have completely sold out of Chinese equities because they aren’t comfortable with the numbers. I have friends that are betting only on volatility and refuse to go long or short. And then I have friends that, like myself, believe we have identified some real, tangible value and are holding onto it with our dear lives against the overwhelmingly depressing hopelessness that has ransacked the entire sector.
It can’t get much worse, and then it does. That’s been the theme. Pessimism is certainly overwhelming optimism. Sell on good news! Get out while you still can! In my opinion, it can’t get much better — if you’re a buyer. As for the general markets? I haven’t the slightest idea in the world. If Chinese demand for commodities or demand in general starts to drop, that could signal that it’s time to move to the sidelines and wait for a huge crash. That said, the FED and global governments everywhere seem to be supporting higher prices of everything these days. Take a step back and look at things from the perspective, what would I do if I had to pick stuff to own for 5 years? In my opinion, it’s still going to be a select group of these incredibly undervalued Chinese Microcaps.
Stocks that I like right now for a 5 year hold include but are not limited to: CNAM, CCME, LPH, NEP, SBAY, CCCL, WKBT, TSTC, CEU, CPQQ, BSPM, SKBI, NEWN, YONG, CHNC, BWOW, CHBT, UTA, GHII, CIHD, GCHT. Below is my brief analysis.
CNAM – On a pro-forma basis, this is one of the strongest names to own with the rampup of their facility that came back online in mid-December.
CCME – We are seeing short attacks on a daily basis. Most of that argument will be seen as retrospectively foolish assuming that the 10-K audit comes back clean.
LPH – Longwei is about to increase their earnings per share by doing an EPS accreditive acquisition in the next 6 months.
NEP – Their latest acquisition is going to result in future cash flows that are incredibly large and go up with oil prices, which I think are heading up over any given future time frame.
SBAY – They currently delayed their recent filing because PWC is getting hands on — and that’s for the 10-Q. By September their ttm EPS should be $3+.
CCCL – Company is real and is certainly very cheap.
WKBT – The recent offering was to pay liabilities that could only be paid via a share offering. That’s why there was an offering. This is the company that I mentioned previously that dropped 50% on blowout numbers.
TSTC – Their A/R are huge and very credible. We should start seeing significant cash flows rolling in from their A/R here shortly.
CEU – Cash was proven to exist. Company is trading at less than net cash and is growing.
CPQQ – Breaking into a huge industry. Very cheap, lots of room for growth.
BSPM – Biostar has Mazars as an auditor. I respect that.
SKBI – Recently upgraded auditors to Crowe Horwath.
NEWN – Good auditor and makes batteries for Apple products.
YONG – KPMG as the auditor. Shorts can’t even write legitimate hit pieces against Yong, which is growing at roughly 50% a year.
CHNC – I imagine that only the stock price is all that is keeping this from a NASDAQ listing.
BWOW – Incredibly cheap based on their guidance. I figure that the earnings are going to be variable given the industry.
CHBT – Been accused of fraud and the put premiums are high. I’m looking at selling puts here as well.
UTA – Another company accused of fraud that I believe is real.
GHII – The CFO hasn’t sold a share, ever. Also, this one is beyond jokingly cheap.
CIHD – I like Mazars as the auditor.
GCHT – Deloitte is the auditor and everyone I’ve talked to who is familiar with the company says good things.
You can be certain of one thing. I will continue to do my best to ensure that uncertainty will certainly work for me.