New Dragon Asia: How Much of a Bargain?

| About: New Dragon (NDAC)

New Dragon Asia Corp (NWD) produces and distributes noodle and soybean products to wholesalers and retailers in China. It's in a stable industry, provides a diversified array of food products to various customers, has a P/E of 4.2 and a P/B under .5, warranting a closer look.

As we've discussed many times now, you cannot properly value a company without reading the notes to its financial statements. It is too easy for companies to hide off-balance sheet obligations, such as the examples of operating leases and corporate airplanes that we've discussed.

Another reason to read the notes to the financial statements emerges for NWD: stock options. On the surface, NWD has listed its number of shares at 58 million. Throughout the notes, however, we find three separate convertible securities that, if exercised, represent significant ownership share:

1) 8 million options outstanding thanks to an employee stock-based compensation plan
2) 6.5 million in warrants outstanding that have been issued to various financiers
3) 8 million shares of preferred stock convertible into common

All in all, you may think you're buying a company with 58 million shares, but it could very well have 80 million shares if all these options get converted. Does this automatically eliminate it as a buy? Not quite, but these options (which have varying strike prices and maturity dates) must factor into your valuation. In general, value investors tend to avoid companies with a high number of options due to the uncertainty involved, and the warped incentives they provide to management, which we've discussed here, and demonstrated by example here. Proceed with caution!

Disclosure: Author does not own a position in NWD