As the S&P hovers just above a PE of 20, we thought it might be a good time to explain why we feel some US listed small caps operating in China may be safer investments than traditional American Blue Chips. It’s hard to fathom a world where companies trading on the OTCBB could provide more security than those on the NYSE, but in many cases we feel this is absolutely correct.
First, we’d like to point out that our strategy seeks capital gains through stock price appreciation. Thus, we determine risk by the price paid for any given equity relative to the potential for price appreciation/depreciation. The lower the valuation, the less risk we assume and vice-versa.
With that philosophy in mind, here's why we believe some companies on the OTCBB may present less risk than those in the S&P:
First, the valuations in the S&P are fair at best. However, our goal isn't to pay fair price. It's to play below fair price. Right now we see some US listed Chinese companies trading at a tremendous discount to their American counterparts. Why buy a company with modest growth potential trading at 20x's earnings, when you could buy a company with significantly more growth potential trading at 5x's earnings? It's just common sense.
The second reason we believe Chinese companies on the OTCBB present an attractive opportunity is the Chinese economy itself is growing at a much faster rate than the American economy. However, much like mainstream investors fear smaller exchanges, most fear companies that operate in China. They commonly cite reasons like “lack of regulation," "companies cook their books," and "China's blown a bubble." Need we remind investors that Enron traded on the NYSE, Bernie Madoff is the former chairman of the NASDAQ and China's stimulus was less than ours (and they've already taken steps to raise rates)? If they're bad, then what are we?
There's also the issue of "sovereign fraud." That China misrepresents their growth, and thus the companies over there aren't worth investing in. Again we believe this fear is totally unfounded as all economies “cook their books” to some degree. Just look at how the US reports unemployment. There’s absolutely no proof that the Chinese fudge numbers any more than their American or European counterparts. And while it’s important to do your homework and look for signs of fraud, it’s foolish to write off every business that operates in a given country because that country may or may not accurately represent macroeconomic figures.
The final reason we find OTCBB stocks so attractive is they all have the potential to uplist. And when they do, a nice increase in stock price usually follows. Nothing fundamentally has to change with the company. They don’t have to increase sales or improve margins. Their stock is simply traded on a different exchange and the investors with the guts to back them from the beginning get rewarded handsomely. Keep in mind, stocks on the NYSE only have one place to go, and that’s down.
Thus, it is our opinion that feelings of exchange and economy based "safety" or "risk" are pure delusions. Only the underlying companies themselves should provide those feelings. However, these common misconceptions have afforded us a tremendous opportunity, as many fundamentally sound, fast growing and honest companies on the OTCBB trade at an extreme discount to their larger counterparts simply because of where they trade and/or operate. Companies like ALIF.ob, CNOA.ob and BSPM.ob have all reported consistently solid earnings, boast fantastic growth potential, and trade with PEs that are a fraction of the S&P aggregate. And given our strategy, this gives us far more comfort than Mary Schapiro, or any other bureaucrat ever could.
Disclosure: We hold positions in BSPM.OB, CNOA.OB, and ALIF.OB as well as a portfolio of US listed companies operating in China that trade on the OTCBB. The statements made in this article are not intended to be investment advice. Please consult a qualified investment advisor before making any investment decision.