Recently, US-listed Chinese companies have seen a massive slump since the 2008 financial crisis. The NASDAQ Golden Dragon China ($HXC) has dropped from 20,500 in Feb 2021 to only 10,400. In the last five months, around $770 billion have been wiped off from the market value of US-listed Chinese public companies.

Many new restrictions such as anti-monopoly policy, Alibaba’s ($BABA) $2.8 billion fine, and the requirement for Tencent to relinquish exclusive music licensing rights major record labels globally, has affected those companies stock prices negatively. The latest blow came from new Chinese regulations on private tutoring businesses. This new regulation does not allow those companies to go public for financing, and foreign capital could not invest in those institutions.

When Alibaba went public in the U.S., we’ve got many questions about whether Alibaba is a good stock to purchase. Although Alibaba is a great business, what we had always been concerned about is corporate governance. Most US-listed Chinese companies has gone public with the Variable Interest Entity (VIE) structure. With this structure, investors do not own a piece of the listed businesses. This structure works as follows: The Chinese companies create a Cayman Islands company, which has complex legal agreements with the Chinese companies on the mainland. What foreign investors buy are the Cayman companies. Although it is still a potential risk for investors, this structure has been existing for years and it seems everybody is okay with that.

Many investors have wondered if they would like to purchase US-listed Chinese stocks, what would be the best to purchase. Here is our quick summary of several big boys including Alibaba, Tencent ($TCEHY), Pinduoduo ($PDD), and JD ($JD), so we can choose the best ones.

1. $PDD: 100% sales growth, unprofitable, negative EBITDA, trading at 5x forward EV/Sales.
2. $BABA: 40% sales growth, 12.5% operating margin, trading at 3.5x forward sales and 26x forward EV/EBIT, ROC: 7% – 12%. (Past 5 yrs)
3. $TCEH.Y: 28% sales growth, 26% operating margin, 6x EV/Sales & 20x EV/EBIT, ROC : 12%- 18%.
4. $JD: 30% sales growth, 1.2% operating margins, 0.6x sales & 56x EBIT, ROC 4%.

By looking at these numbers, Tencent seems to be standing out. Although Tencent has the lowest growth among the three (but still 28% growth), it is the most profitable, highest operating margin and trading at the lowest EBIT multiples. Moreover, Tencent has the highest return on capital among those four companies. If investors prefer growth, Pinduoduo, with the highest sales growth, is the company which investors should look deeper into. In this post, we will look at Tencent.

We think that in a long run, Tencent would be the most sustainable business among those four companies for long-term investors. It has a full ecosystem covering e-commerce, cloud, music, gaming, and artificial intelligence. One of the most widely used super-app in China is WeChat, which is the platform for social media, payments, e-commerce, advertisement, etc. Chinese consumers do everything daily on Wechat, including talking/chatting with other people, reading the news, shopping, working, paying, and sending/receiving payments.

Moreover, the company invests in many platforms of the future, including cloud, AI, blockchain, 5G, quantum computing… to gradually build up its Metaverse.

Here is an interesting Tencent’s Metaverse picture:

Source: NASDAQ

At the beginning of last year, the company announced that there were around 800 companies in Tencent’s investment portfolio. Around 70 of these were already listed, while more than 160 are unicorns. Previously, the company’s investment activities focus on content, video games, and new technology. In the future, it would pay more attention to smart retail and its payment platform, developing its own mini-app ecosystem in its Wechat super-app.

Basically, we view Tencent to become one of the biggest and most successful venture capital nowadays. Furthermore, its investment activities support its own Metaverse, creating great synergies and possible collaborations among those companies.

Let’s do rough projections and valuation for Tencent to 2025.

If we assume that from 2021 -2025, its revenue growth would be around 25% per year, operating margin stays around 25% (lowest in the past five years). By 2025, Tencent would produce nearly 1.45 trillion RMB in revenue, 362 billion RMB in operating income. With 19x EBIT multiples (to put in the historical perspective, the lowest multiple in Tencent’s history is 19.09x in 2011), Tencent would be worth more than US$1 trillion by 2025.

If Tencent’s total outstanding share will slightly increases to 9.6 billion by 2025, its share price would be worth $104 per share, roughly 70% upside from the current share price.

In summary, Pinduoduo would fit with the high-growth investors, as it has the highest sales growth at 100%. Tencent, on the other hand, seems to be the safest bet among those four Chinese companies. With its growing metaverse, decent sales growth, high operating margin, and return on capital, Tencent would serve well in the long-term investors’ portfolios.

Many investors keep trying to find 100 baggers. For companies with an excellent management team, growing dominant market position in the niche market, having products that customers trust and love, 100-bagger will happen sooner or later. If a stock does 100x in 33 years, it is compounding 15% per year, which is already extremely good. However, there are several exceptional businesses which is doing that much faster. Today we will look at one of them.

Source: Google Finance

XPEL manufactures and distributes automotive surface and paint protection, automotive and architectural windows films, and ceramic coatings. The company had moved its focus from selling its DAP film cutting software to selling its own PPF products. It used a direct distribution method, selling directly to installers. Its DAP cutting software also helped installers to cut precise film patterns to save time and increase precision. The company had no customer concentration, and the customer switching cost and barrier to entry were high. In addition, it had established a dominant market position. There were also a lot of growth opportunities in international market expansion.

In 2014-2015, it was a pretty small company, but the growth was quite good. From 2008 – 2015, its total sales had grown from $3.5 million to $41.5 million, 42.4% CAGR. The company turned profitable in 2009. Its operating income increased from $170k in 2009 to $2.7 million in 2015. During that time, its return on capital had been superb, staying in the range of 18% – 36%.

Source: TIKR

Because it was small and traded only in Canada on the TSX Ventures and over-the-counter market in the U.S, not a lot of investors noticed it. Although demonstrating high growth, in the first quarter of 2016, it was valued cheaply on the market, with only 0.54x sales multiple and 8.5x EBIT multiples, around $1 per share, with only about $30m in enterprise value.

Fast-forward to today, XPEL is trading at $100 per share, with a $2.78 billion in enterprise value. Its current valuation is much higher. LTM Sales multiple reaches 15.2x, and the EBIT multiple balloons to 94x.

Warren Buffett has once said: “If I was running $1 million today, or $10 million for that matter, I’d be fully invested…. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.” Does his 50% return confidence come from company with wide moats, special situation or cigar-butts? Personally, I think it would be cigar-butt and no-risk strategy. Charlie Munger also mentioned that he made $80 million in several years by investing in a cigar-butt company. Those facts have encouraged me to begin my journal to find cigar-butt companies around the world. However, we could not find any newsletter or sources, which can feature good companies selling at a very cheap, cigar-butt price consistently. That is why we started Global Hidden Gems Portfolio in January 2019. www.ghginvest.com.

In the Global Hidden Gems Portfolio (GHGInvest), there are three main strategies which can cater to DIY investors:

1. Global High Dividend Yield Portfolio: Global Stocks which have been paying uninterrupted dividends for the past 10 years, with a reasonable payout ratio and have been growing dividends for the past 5 years)
2. Global High Growth Portfolio (Peter Lynch Style): Global Stocks which have been growing EPS more than 15%, with consistent EPS growth for more than 3 years, reasonable leverage, and trading at less than 1x PEG ratio.
3. Global Net-Net Portfolio: Global Stocks which are trading less than its net working capital, which is categorized as net-nets under Benjamin Graham strategy.

In addition, every month, we feature one or two stocks which are clearly undervalued under cigar-butt strategy. Profitable companies which are trading less than their net cash. As simple as that. Rationally, a company which is trading less than its cash, even net-nets, often produced huge losses, which eats into their cash balances over time. However, we dig deeper to find the extreme irrationality in the market. How can a business which earns $1 in profit every year, has $10 in the cash balance, employ no debts, but sells in the market for only $5? But that is the typical characteristics we are looking for. Some of them are even paying good dividend yields as well.

Within one year, with 13 issues, GHGInvest has been lucky to find up to 15 situations which are all making good money, which makes our subscribers quite happy. If we put in $1,000 in each of our picks, we will end up with nearly $22,170. Please bear in mind though, investing in cigar-butt involves three risks: the risks of investing in global markets (can be certain accounting frauds which we could not identify), illiquidity risks (which we tried to minimize), and the currency exchange risks (which we can hedge by forward/futures currency contracts)

Here is detail return of each pick (the details of the picks are only available to our subscribers).

Indeed, the cigar-butt investing still works well. Although it requires extremely hard and long-hour work, the results can be quite rewarding when we can find those opportunities.

Happy and Successful Investing!

GHGInvest

www.ghginvest.com

I am Anh Hoang, the Chief Investment Strategist for Global Hidden Gems Portfolio (https://ghginvest.com). As a value investor myself, I have been following the value investing style of Warren Buffett, Charlie Munger, Walter Schloss, and Benjamin Graham for more than a decade. We have just launched the Global Hidden Gems Portfolio since the beginning of 2019. And our handpicked stocks meet only one simple investment criterion:

Companies that are trading at less than its net cash on their bank accounts, but still operating profitably and/or have huge valuable assets.

It is very hard to get wrong when we choose a stock portfolio which meets the above criterion.

Two typical situations in the past

Case 1: 

In 2013, a no-debt company has $20 million of cash in the bank, its assets and patents are worth around $50-$60 million, but it is trading for only $10 million on the public market. There is NO WAY that a private company can be sold at this unimaginable and ridiculously funny price. A patient investor can do well by buying a small piece of this business and wait. That company is called Digital Media Professionals. 

A result? 10x in ONE year. The share price jumped from ¥530 yen to ¥5900 yen.

Source: Google Finance

(More on that story at Investment Philosophy)

Case 2: 

Another Japanese company has nearly $130 million in its net cash, had been trading at ¥1,400 ($12.36) yen per share, making the total market cap of only $108 million, much less than its net cash on hands. It has been profitable since 2014 and growing its income really fast. Moreover, this company has a long history of paying consistent dividends. A ridiculously deeply-undervalued stock. It is called Kitagawa Industries.

At the beginning of November 2018, Kitagawa Industries got the buyout offer of ¥3,943 ($34.80) per share, nearly tripled the market price before the buyout offer, delivering sweet returns of patient investors.

Source: Bloomberg

Our January 2019 issue

In this issue, we have picked two Japanese companies and one Korean company which meet that single criterion, trading at less than its net cash but still profitable. What makes them interesting is they have been growing sales and operating profit consistently. Moreover, all three are paying growing dividends to their shareholders.

Here are the results after we have picked them on our issue of January 2019.

Our handpick monthly investing newsletter is just one out of four things that our subscribers get. In addition, as a Platinum subscriber, you can also get:

1. A Monthly Global Sustainable High Yield Income Stock Screener, which screens stocks fit these criteria:
   1. Paying consistent dividends for at least 10 years
   2. Been growing dividends consistently for at least 05 years
   3. The payout ratio is reasonable, below 66%
   4. 05-year average dividend per share annual growth is more than 5%
2. A Monthly Global Growth and Sustainable Stock Screener (Peter Lynch Style), which screens stocks fit these criteria:
   1. Market capitalization is less than $5 billion
   2. EPS growth consistently for more than 3 years
   3. PEG ratio is below 1
   4. 05-year average annual EPS compounded growth is between 15%-30%
   5. Conservatively leveraged, with debt-to-assets at most 50%.
   6. Low following by analysts/brokers.
3. A Monthly Global Net Nets Screen, which screens all PROFITABLE net-net stocks around the world (excluding financial stocks).

• PRO subscribers ($89 per month) can get High Yield Income Stock Screener and A Monthly Global Growth and Sustainable Stock Screener.
• PLATINUM subscribers ($129 per month) can get ALL THREE SCREENERS and A HANDPICK RARE-TO-FIND Global Stocks in our monthly investment newsletter.

To prevent quick ramp-up in prices of those undervalued stocks right after we find it in the Global Hidden Gems portfolio, the service will be open to ONLY A LIMITED NUMBER of investors. After that, it will be closed to the public.

For more information and inquiries or suggestions, please email directly to me at anhhq@ghginvest.com or contact Member Support at membersupport@ghginvest.com.

Have a great day,

Best regards,

ANH HOANG

Chief Investment Strategist

Global Hidden Gems Portfolio

GHG Invest