Saturday, July 12, 2008

A Thought-Provoking Post by Aaron Edelheit

It turns out that Aaron Edelheit has a blog ("Investing in a Life of Value"), and a rather eclectic one at that. In addition to investing, Edelheit writes about religion, self-improvement, humor, and healing the world. A gentleman and a scholar, apparently. Here's a thought-provoking post of his about investing from last month, "Thinking of Investing in China?". Excerpts:

4.71%

That is the average annual return from investing in the MCSI China index since March 31 1998. This despite 40% average annual returns in the past five years.

I use this startlingly data point to make a much larger point. Sometimes large economic trends do not make great investments. And obvious top down trends don’t always make good investments.

[snip]

I believe China faces some serious headwinds going forward. Everyone seems to think China can spend anything it wants on commodities such as oil, iron ore, copper, etc., but they don’t. And when you add in the fact that China is about to start importing vast amounts of food as well and that they have a problem with water and one realizes that the country has serious import problems to overcome. And this doesn’t even take into account, the lack of accounting standards, mounting banking problems, a surging gap between between rural and urban Chinese and a lack of clear private property laws.

So before commentators and so-called experts try to convince you to invest in something hot like China consider the longer term record of investing in the country and look deeper into some of the issues affecting the country, you might be surprised by what you learn.

For the record, I have no investments in China or any company listed anywhere that has major operations in China. For reasons I cite above, I believe there are better risk/reward situations elsewhere, especially in North America.


This post reminds me of an article I read several years ago on the trade website 401kwire (bear with me for a moment, and you'll see where I'm going with this.) At the time, I was working in business development for a start-up company in the 401(k) industry. As a web-based, mostly paper-less enterprise, my company could profitably administer retirement plans for small companies. One of the bullet points we mentioned to potential investors was that (I forget the exact numbers) 80% of American small businesses with fewer than 100 employees didn't have a retirement plan, and that represented a huge potential market for us (of course, a significant percentage of these small business had high turnover, or low-paid workforces that could make a 401k impractical, etc.). After a couple of years at this company, 401kwire published an article in which the writer called the small plan market the "China" of the 401(k) industry. The writer dug up a quote from the late 19th Century by an officer of an American company that manufactured matchbooks, in which the American businessman spoke about the potential profits from selling matchbooks to however many Chinese there were back then. His point, of course, was that sometimes markets that look like huge potential opportunities remain potential opportunities (as opposed to actual ones) for a long time.

Edelheit makes some good points about the challenges facing China, and the risks of investing directly in the country, but I think there are ways to profit from the industrialization of China indirectly, by investing in companies based outside of China that are positioned to benefit from this trend (e.g., companies exporting food or raw materials to China, etc.).

7 comments:

Daniel said...

Don Coxe's investing mantra for many years has been to avoid the companies that compete with China and gain exposure to those that make what the country needs but can't produce (enough of).

This led him to the field of commodities. And the mantra there has been to own "long-life reserves in politically secure portions of the world."

I think both of these theses are still valid, but they're also a bit harder to play--as the commodities bull market is farther along, more people are aware of it (so you're paying more for value) and political risk has increased--everywhere.

Thanks again for the Edelheit blog link! I agree with him on this one that the macro trend isn't an end-all. In fact, especially with China, if you're bullish on the currency, there's a lot of companies you don't want to own there.

When the macro trend is strongly bullish, however, while companies within that area are priced cheaply (such as Hemisphere GPS), chances of success are high

DaveinHackensack said...

I generally agree with you, particularly about the sweet spot when you find an inexpensive company that nevertheless has a strong macro trend tailwind behind it. HEM fits this, and I think, in a sense, AYSI is the HEM of the mining industry. Both are positioned to benefit from the growth of China as well.

DaveinHackensack said...
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J K said...

Some of my best performing stocks have been with Chinese companies. With the chinese market down the way it is, I think a lot of Chinese ADR's present good values. I'm not a fan of comparing broad indexes to determine what investments "work" (value vs. growth, large cap vs small cap, china index etc) since what individual companies you actually buy at a certain price determines your returns, there can be more or less junk in any broad index.

With that said, I doubt I'd ever consider a Chinese stock a "buy and hold forever" investment. I've become quite concerned with how management of Chinese companies views their shareholders. Not just Chinese mangaement, but emerging market managements in general. They always seem to jump for dilution to fund all expansion, and the awarding of stock options gets pretty crazy too. Their view of the capital markets frequently seems to be one of a giant free money printing press.

IMO, Chinese/India stocks are good holdings for the 1-3 year timeframe where you can find value...but I wouldn't buy them for your retirement plan. The Chinese companies I own now are poised to benefit for years to come from some under-recognized macro trends in China (western-style pharma, water shortage, natural gas vehicular fuel) so I'm not too worried about the negative headwinds facing the country as my companies would benefit. A good way to play it is to find a small under-reported growth company, look at its plans for growth, and sell when it reaches a good % of their planned growth. For example SinoEnergy has a nat gas contract with PetroChina that would enable them to run 150 nat gas stations-The plan for me is to sell when they reach maybe 120 or so stations, unless we become grossly overvalued along the way.

Thanks for the link to the Edelheit blog, there is some interesting stuff in there. Reading about his time in Israel and Torah/Kaballah studies was interesting. Funny how simple contradictions become thought provoking koans if you assume inerrancy. The human mind is quite imaginative.

DaveinHackensack said...

Thanks for that informative comment, John. Good point about the indexes too.

Regarding dilution, one of the things I like about Alloy Steel is that there hasn't been any dilution yet.

J K said...

Yes and that fact makes it a rare gem of an OTCBB company. Even the good ones typically hang aroung the OTCBB for a little while getting private placements etc before graduating to a senior exchange (like AOB for example).

So its refreshing to get one like an AYSI or BOBS that doesnt dilute.
To see how even the big board foreign stocks dilute to fund growth, just check out how Tata Motors (TTM) funded their ill-advised Land Rover purchase. Investors weren't too happy with that deal. Incidently I think TTM is a good value now, but investors who bought at a fair valuation of 15 bucks sure aren't too happy. The institutions really dumped on that news.

P.S. Dave, just a thought: Have you considered on the front page of your blog, putting a summary of the entry with a "click-to-view-more" hyperlink to an expanded view that shows the whole post? That way it would be easier as a reader to navigate, identify, and pick the entries, IMO. There would also be more entries on the front page to view, making it less likely entries get missed or skipped over. Just a suggestion. Great blog either way!

DaveinHackensack said...

That "click to read more" feature is a good suggestion, particularly for long posts such as the Stratfor one. Let me see if I can figure out how to do that...