Back in 2006-2007, many private investors had it easy. The markets were on a tear and UK investors were benefiting from a boom in new flotations on AIM. Amongst them were a ream of Chinese listings which were attracted to AIM in order to raise growth capital. These included the glamour stock Renesola (LON:SOLA) , a solar wafer company which proceeded to sextuple over about 18 months amongst much decadent howling from private investors on the bulletin boards. Of course it couldn't last, and Renesola, as well as most of the other Chinese stocks, crashed during the credit crunch.
Picking up the pieces today, there are a few Chinese AIM stocks that have recovered somewhat, with some such as Asian Citrus (LON:ACHL) posting very strong gains and moving to new highs, but there are also many that have remained bombed out predominantly on size, accounting and cashflow concerns. The worry that many investors have is that they just don't trust these companies, and don't trust the companies' accounting practices. As a result these companies now trade on completely derisory ratings - to such an extent that they are now appearing on our screens as selling for less than their liquidation value.
Ben Graham, the famous value investor and tutor of Warren Buffett, was the ultimate contrarian investor and loved derisory ratings. He was the investment world's first ever 'quant', running his investment fund for many years almost purely based on a statistical strategy that looked to buy bombed out stocks for less than their liquidation value. Graham wasn't shy of investing where others feared to tread as he believed that in a well spread portfolio any individual bankruptcy risks could be diversified away. Holding anywhere from 30 to 100 stocks, he found the investment returns that resulted to be 'more than satisfactory', with his Graham-Newman partnership returning 17% per year.
If you take a Graham approach to the market, you look for companies that are selling for less than what investors would receive in the worst possible scenario; a liquidation. In this scenario, there's really little point the companies remaining on the market as investors could just liquidate and make a profit. Knowing that in a firesale companies might not get full value for their assets he used an extremely cautious calculation to value them. In his 'Net Net Working Capital' approach would ignore all fixed and intangible assets (property, brands etc) and focus on the liquid assets that could be sold quickly, i.e. the cash, stocks and debtors net of all creditors. Graham liked to find companies that sold for a price of less than .7 times this figure to give himself a significant margin of safety. While there are still occasionally companies that qualify for this margin of safety these days most investors allow higher multiple of up to 1.5 times due to their rarity.
If you screen the market on these attributes you find three Chinese AIM stocks come up on your screen amongst the cheapest in the market. Some of these used to be popular amongst private investors but which now can only be described as long term dogs from a performance perspective. The following figures are from Sharescope and Sharelock Holmes.
- RCG (LON:RCG) , a biometric and RFID specialist, which sells at a market cap of £65m, having net current assets of £167m incorporating cash of £25m - Price/net net working capital ratio of 0.7.
- Geong (LON:GNG) , a company selling enterprise CRM solutions, selling at a market cap of £12.6m, having net current assets of £16.3m including cash of £6.4m and no debt - Price/NNWC ratio of 1.12.
- Taihua (LON:TAIH) , a company cultivating a Yew extract Paclitaxel needed for the treatment of cancer, selling at a market cap of £11.2m, having net current assets of £10.5m which includes cash of almost £8m and no debt. Price/NNWC ratio of 1.26.
All are undoubtedly cheap bombed out stocks, but all have serious question marks against them. Geong recently presented to a group of private investors and many were left with the impression that their revenue recognition policy was too aggressive. RC Group has suffered due to cashflow concerns and also because it has been embroiled in one of Hong Kong's most high profile court cases. Taihua hasn't delivered on investor expectations and suffers from being extremely small.
The trouble with these Chinese AIM stocks is where are the catalysts? Without a dividend, without complete trust in the accounting policies, without a huge turnaround in fortunes they are at the peril of a market that just isn't interested in the unfashionable and obscure. Many investment funds, and even the deep value funds, won't touch foreign companies on AIM due to checkered histories. Investors buying such companies must be aware that they could end up being the ultimate 'value traps' than never return to a fair value.
But the great irony is that there's always a reason to hate a Ben Graham Bargain stock, that's why they are bargains. Graham took confidence in knowing that markets over-react and that people tend to throw stocks away when they don't like them at irrational prices. By diversifying away the individual risks Ben Graham found that a portfolio of basket cases can lead to 'highly satisfactory' returns - returns that unfortunately have been elusive to many investors in foreign AIM stocks for a long time.