Opportunities In Out-of-favour Stocks

I agree with Happin’s comments on Cacola and Ziwo but would like to add that -
1.      For CACOLA: although it has very little downside (52-week-low is 4 cents) and (possibly) very high potential gain, it is definitely not in the same category of turnaround stocks like Sunvic, Bright World and others, where the recovery of earnings was very substantial and impressive. Cacola’s turnover for 2Q10 & 3Q10 were RMB 111million & RMB 104 million respectively. The nett profit for 2Q was only RMB 3.68 million and dropping to RMB 1.4 million in 3Q. This is rather discomforting because should the profit for 4Q (due in Feb 2011) remain flat or fail to meet expectations, we may see little or no capital gain for some time. A good example was Changtian; its earnings were turning around nicely for the first 2 quarters until it reported a profit plunge of 76% in its third quarter results. Its share price then kept sliding after that. My personal view is that it may be wiser, at this stage of the market, to look for other better stocks that have lower risks and where capital gains are more certain and achievable over a shorter time period.
2.      In the case of ZIWO, its performance has been rather impressive and its share price has already risen from around 25 cts in early September 2010 to the current level of 36 cts. Although its PE is now around 5x, it may still have further upside in the near term because of its impending dual listing in Taiwan and a likelihood of releasing a very good set of results in February 2011. As for the risk on accounting fraud, I feel investors should not be overly concerned over this because the risks of accounting fraud, poor corporate governance, bankruptcy, etc. are considerably less (though not impossible) following a severe bear market or economic recession. The badly managed companies would already have landed themselves into serious trouble; and those companies that had concealed any serious misdoings are unlikely to be able to continue doing so without their misdeeds coming to light through the hard times. Risk factors are normally at a very high level at the start of a bear market or economic downturn leading to serious deterioration of business. It is at this time that companies or top-level corporate personnel facing serious financial problems, could be tempted to resort to doing various misdeeds. This was well illustrated in the last bear market when many S-chips gone bankrupt or had their misdoings exposed. History could likely repeat itself when the next bear market and economic recession set in again.
All investments have risks and each of us must learn to manage our risks well taking into account our risk appetite, resources and knowledge. There is no right or wrong investment strategy so long as one is comfortable with what one is doing and that at the end of the day one ended up with a very healthy bottom line that meets one’s objective.
 

Adding to observer2's view, I recall that the profit of Cacola in the year to date shld be viewed cautiously as it comprised a writeback for provision of a bad debt. In other words, the operating profit was not so sexy. Still some way to go for its business to show the kind of profitability that it enjoyed in the pre-crisis days. Having said that, the upside % potential is immense if ..... 4Q results pick up smartly and, as happin conjectured, there is a 1-cent dividend

Ziwo has moved up to 40 cents! Stock is only 5X PE, with high profit growth to continue.
On Tuesday, Ziwo will be presenting at CIMB.

The Sunday Times of 16 January 2011 featured an article – “Don’t Bank On “Greater Fool” Theory”. In the article, the writer highlighted the winning strategy of a successful gambler, Puggy Pearson, that investors in stocks could also consider adopting – (see write-up reproduced below):
“The late Mr Puggy Pearson, a colourful gambler who won the World Series of Poker in 1973, once said that the key to his success boils down to three things.
'Know the 60-40 end of a proposition, money management, and know yourself,' he said.
In a 60-40 proposition, a gambler has a 60 per cent chance of winning a bet.
Take horse betting. The expectation that a certain horse may win is reflected by the odds given on the scoreboard, while its performance will depend on its form during the race.
Mr Pearson noted that a gambler does not make money knowing which horse will win or lose. Rather, he makes the big bucks from knowing whether the odds on a horse have been mispriced.
Stock investing is similar in some ways. How a stock performs will depend in a big way on investors' expectations, rather than the income which its business may be making for them.
One mistake made by most investors is the urge to want to buy stocks which are on the upswing - and sell when the picture looks bleak.
It may be better for them to look out for counters with good businesses which have been unfairly priced down by the market.
They will then enjoy a better chance at making money out of these counters.
Take the huge bear market between December 2007 and March 2009. Solid companies such as DBS Group Holdings, OCBC Bank and Singapore Airlines tumbled to their lowest levels in almost a decade, as investors' expectations hit rock bottom.
This is a classic case of the odds being mispriced, as Mr Pearson would put it, given the attractive businesses possessed by these blue chips.
Since those dark days, those who were brave enough to take a bet on these counters would have doubled on their money.
Going forward, there is likely to be other instances of mispricing of the odds, as investors' expectations take a hit from the spate of bad news hitting the market.
If you take Mr Pearson's advice to heart, you may well find yourself at the attractive 60-40 proposition end of making a profit on your trades.”
Stocks that are mispriced are most likely to be found among the out-of-favour stocks, especially undervalued stocks with good fundamentals that too many investors avoid them or have no interest in them for various reasons. The odds of winning here are considerably superior to the 60-40 proposition discussed in the article.

With the improving market sentiments for penny stocks and S-chips, good out-of-favour stocks are fast becoming a rarity. Those who were brave enough to take a position in such stocks over the last few months would probably be laughing their way now to a good restaurant if not to the bank. Of the 3 examples of out-of-favour stocks highlighted in this thread, all of them have since notched up gains ranging from 25% to 121%.
China Gaoxian [42 cents] – up 121% from 19 cents (20-10-2010)
Qingmei [33 cents] – up 27% from 26 cents (13-12-2010)
Eratat [25 cents] – up 25% from 20 cents (7-12-2010)
At this stage of the market, FUJIAN ZHENYUN appears to be the only good undervalued profitable stock left that continues to remain out-of-favour with investors. Those with an appetite for such a stock may like to check out on this one.
FUJIAN ZHENYUN is principally engaged in the research and development, design, manufacture and sale of a broad range of plastic pipes and fittings for four main piping systems, namely water distribution, communications, gas & electrical piping. The stock had its IPO in August 2007 at 62 cts and is listed in the Second Board [Catalist]. The company has a share capital of RMB 115 million comprising 35 million S-shares listed in Singapore and 80 million unlisted shares, the bulk of it in the hands of the management.
The share price of Fujian ZY took a big plunge in early June 2010 after its previous auditor, KPMG failed to pass its FY 2009 financial account (not in accordance with International Financial Reporting Standards) because of some accounting discrepancies in certain business transactions. Since most investors were already fearful of S-chips because of the many cases of insolvency and poor corporate governance among them over the last 2 years, this incident had further dampened Fujian’s stock price to insolvency level. In July 2010, Fujian ZY appointed Deloitte & Touche as Special Auditor to help resolve its accounting problems. The Special Auditor completed its assignment recently and did not find any accounting fraud or serious misdeed. The company has agreed to implement all the recommendations of the Special Auditor to improve its accounting management by March 2011. However, the share price of the stock has remained grossly undervalued.
The positive & negative points for this stock are as follows –
Positive Points

1. The company has an impressive track record with EPS of around 70 cts (RMB) or 14 cts(S) each year for the past 3 years (FY07-09). Although the profit growth had been rather flat, it is one of the few S-chips that have performed well in its business for FY 08 & 09 while many others had suffered a decline in profit or a loss due to economic slowdown.
2. According to its 1H10 results, the company has cash holdings of RMB 273M and borrowings of RMB 16M. . Its EPS for the First Half is 37 cts(RMB) or 7.4 cts(S) [annualized 14.8 cts]; & its NAV is RMB 4.77 or 95 cts(S). Its PE is only 2.5x at a price of 35 cts.
3. The company’s major customer remains the government-linked organizations and thus faces less debt collection problems.
4. Fujian had declared dividends of 9.96 cts(RMB), 3.83 cts(RMB) & 5.64 cts(RMB) for FY 07, 08 & 09 respectively.
5. For business growth, the company acquired 5 PE plastic pipe production lines in 2008 to boost PE production capacity by about 11,000 tons. In end-2009, it acquired 10 new PVC-M production lines for RMB 52 million to boost its PVC-M water pipes production by about 20,000 tons p.a. starting mid-2010. This is expected to boost its EPS well beyond 14 cts(S) this year. [1H2010 EPS is already 7.4 cts(S)].

Negative Points

1. It is a very illiquid stock and an S-chip - only 35 million issued S-shares in Singapore and rather difficult to buy or sell in sizeable quantity.
2. Market sentiments towards S-chips have yet to recover significantly. Hence, upside of its share price will be limited – may be to PE of 5x or 70 cts ?

 
DISCLAIMER:
Good, undervalued, out-of-favour stocks are likely to give extra-ordinary gains but its risks are also very much higher if there are uncertainty factors. Each individual should do their homework or analysis taking into account the risks vs the rewards before making any investment.

From what I read of the Special Auditors' report, there were a couple of procedural lapses but I guess they are part & parcel of SMEs everywhere.

The one finding that I am more concerned about is the company's transactions with its employees' companies. Now, that's a weird ... but the Special Auditor's report didnt raise a ruckus over it.

The stock will be re-rated if the 4Q results are glorious - and better still if the company proposes a good final dividend. AFter all, they have 44 cts cash (when their stock price is only 35 cents) .....