I know, I know. I'm an advocate of value investing…
I remembered when gambling stocks in Macau were all the rage back in 2012 and especially in 2013. Sure, I agreed that the Macau casino stocks haven’t accounted for the massive influx of Mainlanders incoming to Macau, but then hype and “recent industry growth and company earnings” drove the stock prices to unprecedented levels. I used the word recent because it seems that stock prices have soared due to the latest information they had their hands on, that investors and financial institutions used the most recent data and assumed that the growth would be sustainable.
I didn’t believe the sustainability of the growth of the industry. Now, I’m not saying the industry won’t continuing grow or what not, what I’m saying is that the stock price during 2012/2013 was estimating the casino stocks to continue growing at a much faster rate than I thought possible. There were a couple of reasons. The most talked about reason (and one banks used to justify to their clients why casino stocks have been dropping) is because of China’s increased handling of corruption. It’s a valid reason I accept, since it is the VIPs that are the most profitable for the casinos.
But there’s another reason for my justification – if you think about casinos, basically we know that casinos have the house advantage in every game. So in the long run, every gambler should be losing money to the casinos, statistically speaking. These people that come to Macau to gamble all have a limited amount of income that they can gamble with. Eventually, the gamblers cannot afford to continue gambling and when that happens, the casinos will also suffer as well. These gamblers will need to replenish their money through other means before they can gamble again, and this takes time. Therefore, growth at such a fast pace is in fact impractical in this industry. Long term growth may be possible, but I’d expect the industry to go through volatile cycles and grow at a slower pace.
So I bought a put option for one of the casinos listed in Hong Kong, expiry Dec. 2013. Needless to say, the expiration date I bought it at was too early. In fact, casino stocks were at the top at the end of 2013. However, my conclusion was proven right when casino stocks tumbled this year, 2014, and all the banks were now downgrading their target prices and industry outlook has been dampened.
Going to go off track a little to talk about options… as I’ve mentioned, stock prices plummeted after my option expired. One bad thing about options is that even though your analysis may be right, it may come to fruition at a later time than you’d expect. The market affects the timing, but eventually the stock prices will live up to the true business valuation, but sometimes it’s hard to predict when. Therefore like in my scenario, I lost all the premium I paid for the option. Had I bought the option at a later expiration date, the premium I paid for will be much more costly. Had casino stocks continued rising, I would have lost more money. If I was right, the profit I would be making would be less because of the high premium I had to pay. These are some things to consider next time you do buy an option.
I bring this case up because stocks in the brokerage industry has been exploding this week mainly in part due to the Shanghai-Hong Kong Stock Connect. Now, I do like the brokerage industry more than casino industry just because the former provides a win win situation for both customers and business, whereas the latter is generally a lose situation for its customers, financially speaking. However, as of today 6030.HK is sitting at a P/E of 45 and 6837.HK is sitting at a P/E of 35. Again, we must ask ourselves this question – is this industry’s growth sustainable to justify such high P/E ratios? I mean these brokerage companies have just been listed within the past 3 years and although their businesses are viable, my problem is with the investors – again we are using recent data on hand and concluding that growth is sustainable at this rate. It’s way more speculation than proven results. It’s like drafting an NBA player for his athleticism with no proven track record, hoping he will become the next superstar, only realizing eventually he becomes a bust. These brokerage companies haven’t demonstrated consistent results and investors are already touting it to have the potential to experience a ridiculous growth in the future.
But the thing is, stock markets go through cycles and volume tends to drop when investors become discouraged to see prices dropping or when the market is volatile. The sudden explosion of trading volume may be temporary; this trading volume may not grow as fast as it is currently. Secondly, I believe what’s going on is that since the United States has been increasing their interest rates whereas China is decreasing theirs, a massive amount of hot money is starting (yes, starting) to flow into China. (Side note: I believe China’s stock market has been long overdue for a price surge considering how fucking cheap their stocks are). However, hot money can flow in just as easily as it can flow out.
Like the casino stocks, I do believe brokerage stocks will continue to surge due to hype and bank reports of improving industry outlook (I did say that I think hot money has just started to come into China, didn’t I?), but for long term investors I just don’t see the stock price justifying its current business valuation. Yes, you can bet on short term profits, but then you will be speculating and enduring a greater risk than investing based on business valuation.
At the moment, it seems that small cap stocks are being dumped in favor of blue chip companies. Insurance companies and brokerage companies are the hot trends at the moment. I think Chinese property developers are the upcoming ones. There may be some small cap stocks that are starting to look really attractive (but remember cheap does not = attractive).
Trust the facts on bank reports, but never their conclusions. For example Oct. 10, 2013 HSBC upgraded Biostime (1112.HK) to overweight with target price raised to $80, and a year later on Oct. 28, 2014 HSBC kept the stock underweight, with target down to $17. Jeez. (My friend also told me that Goldman Sachs had underweight 941.HK late last year, but now G Sachs has its target lifted to $113 (BUY) on Sept. 23, 2014. Unfortunately I can’t find concrete proof of the underweight news so if this is true please let me know and I’ll update it here). What I’m trying to say is, sometimes the banks fall into the trap of falling into trends as well, and they use whatever reasons to justify their target prices, even when the analysis may not be thorough (like what I used to do for essays 😛 … I believe we call this confirmation bias?).
Anyway, enough of my bragging and ranting and this and that, back to what the original message is for this post. So I urge you next time when you see banks and news hyping about one particular industry, and that industry stock prices have been growing quickly, think about whether it is plausible that an industry can grow at such a fast rate as it is currently in the long run and what justifies it.
Please share your thoughts and feelings.
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