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A Basket of Bargain Stocks

Ross Givens

38 followers

One of the cornerstones of prudent value investing is nonconformity - a contrarian approach that finds appeal in out-of-favor stocks and sectors. We know that this is where the bargains lie. But when we pull the trigger on a new stock against the advice and consensus of others, it's still hard. Howard Marks (Trades, Portfolio) once commented that most of his best investments start with a feeling of discomfort. So with that in mind, I decided to take a fresh look at the global market in search of an unpopular sector offering a considerable margin of safety.

MY FINDINGS

The Chinese spirits industry. If you feel the urge to stop reading after hearing "Chinese stocks," hear me out.

Without an intimate knowledge of a foreign economy, I would never suggest purchasing speculative small caps or second-tier companies of which you have no working knowledge. The three stocks I have identified have market caps between $3 billion and $22 billion USD. These are international titans with global presences and decades of operational history. They are industry leaders that produce and sell quality liquor, wine and spirits. Basically, they're the Chinese versions of Jim Beam and Annheiser Busch (before it was bought).

The three stocks of our focus are Wuliangye Yibin Co. Ltd. (SZSE:000858), Luzhou Lea Jiao Co. Ltd. (SZSE:000568) and Yantai Changyu Pioneer Wine Co. Ltd. (SZSE:000869). And yes, the six-digit numbers are their ticker symbols.

Together, these three firms represent a ¥106.7 billion market capitalization ($17.18 billion USD) and combined annual sales are $12.6 billion. Compare this with global giant Diageo's (DEO) $17.3 billion in sales and the significance is more apparent. But for the additional 37% of sales generated by Diageo, you'll have to pay an additonal 369% for the stock.

But these stocks are not buys based on low price to sales multiples alone. All three have clean balance sheets with zero long-term debt. They are also carrying substantial cash positions representing 33% (SZSE:000858), 27% (SZSE:000568) and 9.2% (SZSE:000869) of their stock prices. It would take both reckless management and severe economic hardship to send any of the three into insolvency.

I also like to check new stocks against the company's historic price to book multiple. Of the powerful GuruFocus value screens, the Top 25 Historical Low P/B Companies have outpaced the indexes by the greatest degree. The model portfolio is up more than 11.25% this year alone. Given this multi-year track record of outperformance, it has become a personal favorite for identifying opportune buys. Its genius lies in the fact that it compares the P/B of high quality stocks against ITSELF instead of an arbitrary metric or industry competitors.

The three charts below show the 10-year price to book history of each of our three Chinese distillers. As you can see, all are being offered at prices unheard of anytime in the last decade.

For those without Global Membership that cannot access Chinese stock metrics, I have also included the valuation headers for each.

DIVIDENDS

As if the rock-bottom discounts weren't enticing enough, each of these companies pays a healthy dividend.

These yields blow away the 1.81% average of the S&P 500.

WHY THE DISCOUNT?

Like every out-of-favor industry, there is a reason for the discounted nature of these securities. In our case, the price declines are tied to a political shift in China. President Xi Jinping has led an anticorruption drive designed to reduce excessive spending by both government officials and consultants attempting to woo federal contracts.

At first this did not seem significant enough to cause such a strain on a multi-billion dollar industry. Fortunately for me, I happen to work with GuruFocus founder and Chinese-born investor, Dr. Charlie Tian. He explained it to me like this:

"It is very different in China. Very expensive restaurants, what would be 5-star establishments here, are generally filled with government employees enjoying lavish private parties and several thousand dollar dinners. Government officials make up a much larger percentage of the spending population than they do in the U.S. While most of the lavish entertainment in the U.S. involves corporate executives and celebrities, in China it is mostly people working for the Chinese government."

So to put this in terms better understood by U.S. investors, it is the equivalent of all Fortune 1000 companies suspending their expense accounts and banning executives from expensive restaurants. Essentially a shift is taking place from over-the-top excess to a respectful level of austerity.

Make no mistake, sales are declining. These stocks are not falling based solely on speculative fear. Revenues are down on the year, but nowhere near to the extent of company stock prices. These three stocks are down 52%, 62% and 71% over the past 24 months even though revenue and profits have been effected far less severely. This is an over exaggeration, and Mr. Market is saying, "Stocks are on sale!"

UPSIDE POTENTIAL

While it is difficult to put an exact dollar amount on the true value of these securities, today's prices are clearly well below the number. In addition to the revaluation that is probably going to occur, these companies are already working on new ways to boost their bottom line. Don't expect them to lie still and take this beating.

According to Peter Evans of the Wall Street Journal, "Consulting firms working in China said they had requests from clients in the spirits industy to help reposition their high-end products to fit in with austerity."

Adam Xu of Shanghai-based consulting firm Booz & Co. echoes these findings: "There is now more of a focus on success than luxury"

Is this a sure thing? Absolutely not. But other than 1% government bonds, what is? This investment does require a small leap of faith - the faith that these industry-leading firms will not sit idly and watch their numbers slide further into the gutter; faith that they will, as many have for 100 years or more, continue to innovate and find creative solutions to temporary setbacks. These companies aren't on suicide watch. None of them are over-leveraged or strapped for cash. They are all financially stable and very much profitable.

Margin of Safety

In addition to the low valuation levels we have already discussed, I chose this small basket of three stocks to add an additional margin of safety. While my savvy Chinese co-worker assures me that all three companies are household names, diversifying this allocation among the three should further isolate the portfolio from catastrophic events. And since wine and spirits have always been a recession-proof business, unfavorable economic conditions are not likely to have a devastating impact.

If you've never invested in China before, this might be a good place to start.

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Rating: 3.7/5 (3 votes)

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Comments

nisquire
Nisquire - 1 month ago
Howard Marks (Trades, Portfolio)'s comment that "most of his best investments start with a feeling of discomfort" echoes eerily the famous observation of Mrs. Malaprop in Richard Brinsley Sheridan's 18th century classic comedy of manners The Rivals: "'Tis safest in matrimony to begin with a little aversion."

JB Marwood
JB Marwood - 1 month ago

How easy is it for US investors to buy these stocks? I have cash account on Interactive Brokers

sjfleming
Sjfleming premium member - 1 month ago

Great article! However, as above how would i go about purchasing these stocks? I currently invest via Charles Schwab who do not entertain Chinese Stocks (like all other brokers i called)?

Any advice on how to invest in Chinese Stocks would be well appreciated

jonyk1976
Jonyk1976 premium member - 1 month ago

I've spotted these stocks by myself several months ago!

Good to see that someone else spotted them as well.

BUT I had to pass them since I had NO way to invest in them

since these are shares A,

and only native chinese have the right to buy them.

IF there is a way for international investor to buy these shares,

I AM INTERESTED!!

mdraphael
Mdraphael premium member - 1 month ago

I have the same question.

I am able to invest in Hong Kong, but I do not have access to Shenzhen Stock Exchange.

JHochhauser
JHochhauser premium member - 1 month ago

Unless you are Qualified Institutional Investors, you will not be able to invest directly in the A Shares. The only way you can get exposure to a basket of A shares is through an ETF such as ASHR, which I think is the best among all A Share ETFs.

paulwitt
Paulwitt - 1 month ago

If anyone is interested in U.S listed Chinese microcaps here is my basket. These are OTC stocks: NUIN, SIAF, LLEN, CICC, CMCI

In my next post I'll mention some stocks that show positive cash flow and can be bought on NASDAQ and NYSE.

BUYER BEWARE: All of these stocks mentioned are potential targets of short sellers. If one is not prepared to do battle do not buy!

paulwitt
Paulwitt - 1 month ago

I pared down a list of U.S listed Chinese smallcaps that show positive cash flow. These trade on NASDAQ or NYSE. Note: I do not own these stocks at this time:

CCCR, JST, XUE, CAAS, SGOC, YONG, THTI, STV, CNET, SUTR, CLNT, ZX, SORL, ALN, SPU, SKBI, CXDC, LIWA, XNY, TPI, GURE, CGA, GPRC, ZA

BUYER BEWARE: All of these stocks mentioned are potential targets of short sellers. If one is not prepared to do battle do not buy!

paulwitt
Paulwitt - 1 month ago

Here's a sample of OTC stocks not reporting. Couldn't take the beating. I have a basket of these.

MSAH,SCEI,SGZH,LPIH,LNDT,VALV,AGAC,ACRB,CCGY,CKGT,EESC,

GHII,VLOV,DEYU,ENHD,ZYCI,CSGH,CHBU,CSHZ,AIVI,CSWG,EMDY,

CICC,DGWIY,CDBT,CPQQ,WTFS,JADA,CEHD,WKBT,DEER,CVVT

paulwitt
Paulwitt - 1 month ago

Using the John Templeton approach to investing in U.S listed Chinese microcaps

John Templeton bought $100 of every stock trading below $1 on the New York and American stock exchanges. Templeton\'s trade got him a junk pile of some 104 companies, 34 of which were bankrupt, for a total investment of roughly $10,400. Four years later he sold these stocks for more than $40,000!

Dr. Paul Price
Dr. Paul Price premium member - 1 month ago

Chinese accounting is notoriously fraudulent.

Relying on reported numbers from Chinese firms when making inverstment decisions can be hazardous to your wealth.

paulwitt
Paulwitt - 1 month ago

An American investor said he doesn't invest in Chinese companies because they keep 4 sets of books, one for the mistress. I was tempted to ask him, what about his 4 sets of books and his mistress. And "notoriously fraudulent" is a short sellers talking point. While there are some frauds last year one of my non-reporting companies China Shandong (CSNH) got bought out and my gain was 1,000%.

So we can only buy China Mobile and Baidu because all Chinese microcaps are fraudulent?

Reduce risk, buy a basket

paulwitt
Paulwitt - 1 month ago

from Yahoo Finance:

GXC (S&P China)/ SPY (S&P 500)

P/E 8.99 / 17.0

P/B 1.10/ 2.33

P/S .82/ 1.65

P/CF 5.05/ 7.31

So Chinese stocks are priced 50% lower than US stocks and their economy is growing much faster. And they're a creditor nation to boot!

paulwitt
Paulwitt - 1 month ago

If no one wants to invest in Chinese stocks then buying US companies doing business in China might be a good alternative. Apple anyone? :-)

JB Marwood
JB Marwood - 1 month ago

Great how this article about Chinese stocks gets sent to my inbox then fails to tell me how I can go about purchasing the said companies. No better than spam.

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