The Market Is Incorrectly Valuing These 3 Companies

Includes: GA, NSU, SBR
by: QuandaryFX

In the following article, I present three companies that prudent investors could potentially purchase for strong gains. Each of these organizations is in the process of a decoupling in which share price is decreasing while firm performance is increasing. I believe that this type of situation enables the adroit investor to profit from market and firm discrepancy.

Prior to examining the organizations, the investor should become familiar with three things: return on assets, return on equity and market cap. Return on assets is a figure that normalizes net income as a percentage of the assets utilized to generate the net income. Return on equity divides net income by direct shareholder investment and gives a number that shows management's effectiveness at utilizing investments to generate returns. Market cap is the value that the market is willing to pay for the firm.

Giant Interactive Group

The first organization that we will examine is Giant Interactive Group (NYSE:GA). GA has experienced a difficult 12 months in which share price has decreased 35%. Prices have recently begun a process of recovery and I believe that there is further upside in store for GA. The following chart displays the fundamental factors that I rely on to make this assertion.

As the chart clearly shows, return on assets and return on equity decreased between 2009 and mid 2011. During these years, the firm experienced a decrease in performance and the market responded by shedding $1 billion in shareholder value. In mid-2011, a clear decoupling occurred in which the firm began performing better yet shareholder value collapsed. When a firm delivers higher levels of performance and the market responds with lower levels of shareholder value, an investment opportunity exists. I believe that the recent increase in performance as measured by return on assets and return on equity will transcribe into higher levels of profit as the organization continues to grind out profits through more efficient use of assets and shareholder investment. I believe the market quickly realized its mistake of assigning a lower value to the firm in 2011 and it is in the process of correctly valuing the organization.

Technically speaking, the market is looking for direction in GA. After prices collapsed in late-2011, the market failed to decline to new lows, leaving GA in a state of directional uncertainty. Since the market has not clearly decided on a trend direction, I believe that investors should stand on the sideline and wait until prices begin to decisively increase. I view $6 per share as a level, which when surpassed, will signal a new uptrend. That said, I feel that the best move in GA is to wait until prices overcome the $6 per share hurdle prior to initiating a long trade in the stock.

Nevsun Resources

Nevsun (NYSEMKT:NSU) has declined nearly 24% this year in a downdraft that erased around $250 million in shareholder value. This decrease in shareholder value has occurred despite the improving fundamental picture of the organization. I believe that the chart below concisely exhibits the true picture of NSU.

As can be seen by examining the return on assets and return on equity, NSU has been consistently increasing its level of performance since 2008. Throughout the past 4 years, NSU has been able to generate increasing profits in relation to assets and direct shareholder investment. This performance has historically been rewarded by the market assigning a higher value to the firm. Between 2009 and 2011, the market cheered NSU's heightened performance by increasing the share price by 780%. Beginning in 2011 however, share price began to decline despite the continuously bettering fundamental picture. I believe that this represents a large mistake on behalf of the market and in the future the market will once again add value to NSU due to its ability to more effectively generate profits.

Technically speaking, NSU is at a critical junction. Price is currently colliding with a strong level of resistance, which is inhibiting further upside momentum. If price is able to overcome $5 per share, then the stock is positioned for additional gains. Since NSU has historically exhibited significant levels of volatility, I believe that cautious investors should wait until price overcomes $5 before taking a position in the company.

Sabine Royalty Trust

Sabine Royalty Trust (NYSE:SBR) is the third company on our list and it also represents a strong purchasing opportunity. Shares have decreased 17% this year in a move that erased $160 million in shareholder value. I believe that this decrease in share price was the result of speculative shorting and shortsighted selling. The chart below shows three elements that I believe capture the fundamental performance of SBR.

The chart shows return on assets, return on equity, and market cap for SBR for the past 5 years. Since 2010, return on assets and return on equity have been steadily increasing. This means that during these years, the company has become better at utilizing assets to generate net income and management has become more efficient at using shareholder investment to generate profits. This increasing performance has historically led market prices, as witnessed by the 50% increase in share price between 2010 and late 2011. In 2012 however, a divergence in fundamental performance and market value began. Despite the fact that the firm continues to perform at exemplary levels, the market value has decreased nearly 20%. I believe that this decrease is a mistake on behalf of shareholders and in the near future, price will continue its upward trend.

Technically speaking, SBR is currently experiencing a short-term pullback within a long-term uptrend. This situation is excellent for investors in that the long-term momentum in the organization is upward and the current decrease in prices enables investors to purchase shares in a trend at a discounted price. I do not advocate an immediate purchase however. I believe that the best time to purchase shares is when price actually begins to increase in the direction of the trend. That said, I believe that if prices are able to increase above $50 per share, then a long position within the stock is warranted.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.