Someone launching attack on FA people on huatopedia. Basically, millionairemind is trying to question an assumption held by some- that there is a PE where the stock will not go any lower. The thread is about busting common investing myths - excellent discussion going on there :)
He argued that,
"If a stock you are looking at has a PE ratio of 6 and growing at a reasonable 10-15% a year, with low debts, would you buy it??? Sure, most FA will say... Remember, the value of a company is what the market prices it at...
If you have bought it at a PE ratio of 6 around 50cts... you would have lost 60% OF YOURE INVESTMENTS BY NOW!!! Would you buy more at say 50cts?? How about 40cts?? 30cts??? It is now 20cts and change. It has a PE ratio of around 3 now. And the SAD news is that this is NOT A MONEY LOSING COMPANY!
The 9months earnings so far is up about 25% YOY. The earnings is of course decelerating but not the company is not making a loss... that is what I mean by the market always knows better and without institutional support, the stock will not move."
Well...let me try to piece up a feeble defence. I have no presumption that I know anything. But firstly, I don't buy just based on PE. In fact, PE is just one of the way I used to calculate the rough range in which the stock will trade. It will never be a valid reason to buy just based entirely on PE. To me, it's a little over-rated. Secondly, it just got IPO-ed on 8th August 2007, meaning that it's just slightly short of 1 year. I personally won't buy IPO stocks (because no matter how much I tikam, I always didn't get any lots!) because the results could be adjusted to 'prepare' for the IPO. I prefer to have it for 5 years at least to have a feel of the company's business before even entering it.
I tried to search for China Hongcheng results - they only have from FY06 to FY07, and 1st to 3rd quarter FY08. Let me ignore quarterly results for now.
I hate doing companies with very short history. Since FY06 is pre-IPO, we mustn't treat it too seriously - this means only one year worth of data.
At first glance, seems like this company's business is doing well. With a gross margin of around 29% and a net margin of 16-17%, it seems rather profitable. ROE of 50%, that's very very high. Let's break down ROE of into 3 components:
1. Financial leverage : Total assets/Total equities
2. Asset turnover: Total revenue/Total assets
3. Net margin: Net profit/Total revenue
ROE = Financial leverage x asset turnover x net margins
Yr---------Financial leverage-------Asset turnover-------Net margins---------ROE
Seems like the reason for their high ROE is from their leveraged structure. Indeed, looking at the current and quick ratio suggest a rather low figure. Total debts to equity paints an even worse picture. If I'm interested in the company, I would do a comp study on other similar companies. Take note that the below comp table is lifted from their presentation slides, dated Oct, 2007. I wonder what the PE of the comparable companies will be like now. Perhaps it will show that Hongcheng at PE of 6x or even current PE of 3x isn't that fantastic.
We can see that the ROE of china hongcheng is one of the highest. But we must break up the ROE to see if the ROE is boosted by high borrowings or not.
Below is the price to EPS (SGD) for China hongcheng,
* note that highest and lowest price is the closing price, not the intraday high or low
** EPS is in SGD
Data of historical PE is too little to be of much use - that's one of the reason why I won't buy IPO stocks with less than 5 years of history behind them.
One thing that screams loudly as I was browsing through is the fact that around 70% of their revenue comes from overseas in FY07 and of that amount, 42.4% comes from US. That's like 30% of their revenues from from US. I'm wondering if their business will be affected adversely should US suffers a slowdown or recession in their economy. Hmm, food for thought.
Of their business, their should start to increase selling more bed linens. My goodness, those have a gross margin of 41%, but takes up only 8.3% of revenue. Most of the product revenue comes from selling grey and dyed cotton fabrics (53.8% of revenue), which earns a gross margin of 21%. Didn't know bed linens can earn so much :)
I guess that's my feeble defense. I don't even think it's a defense, haha, I'm just thinking out loud on this company. I anyhow anyhow did some valuation, using 10 yrs with no terminal value, discount rate of 8% and EPS growth of just 10% (it's around 20%) - I get around $0.80 per share. Seems like good value at current price of $0.20 - I'll likely get like 15% returns in 10 yrs. But this company is too young to be sure. As long as the EPS grows up by than 10%, I think roughly roughly lah.
Don't hurt me too badly, millionairemind :)