Rising Star Sell: Lightening the Nam Tai Position

This article is part of our Rising Star Portfolios series.

When you've made a mistake in your portfolio, the best thing to do is to fix it, not hope that the situation will improve. "Hope" is not the way to investing success. Today, I'm fixing a mistake I made with the Messed-Up Expectations portfolio's position in Nam Tai Electronics (NYSE: NTE  ) .

Let's roll the tape
Nam Tai primarily makes LCD modules and other electronic components for consumer electronic devices. Its customers include Epson, which uses the LCD modules in making cellular phones, and Sony (NYSE: SNE  ) , which produces home entertainment products from Nam Tai's components.

In the original purchase announcement, I called out several good things happening at this company.

  • It is debt-free, unlike its two competitors, Jabil Circuit (NYSE: JBL  ) and Flextronics International (Nasdaq: FLEX  ) .
  • It stayed profitable during the recession, again unlike its two competitors.
  • It hadn't made significant acquisitions prior to the recession that could have led to large writedowns of the resulting goodwill, as did Jabil and Flextronics.

I also mentioned a couple of risks, including its location in China and exposure to any significant slowdown in the world economy.

One risk I hadn't seen was a natural disaster. That first purchase was made the day before the earthquake and tsunami hit Japan. Unsurprisingly, the company's shares took a significant hit because many of its suppliers were located in Japan.

And then greed set in
After waiting a couple of weeks and with shares sitting about 12% below my original purchase price, I announced that I was taking a second position. And by doing this, I made two mistakes.

First, I should have waited for the first-quarter results. The quarter was just ending and I should have been patient enough for management to announce results in early May. This would have given the market a chance to further settle down after the events in Japan, along with giving time for some of the uncertainty about suppliers to be resolved. It would also have given me a chance to learn from management the extent of any effect the disaster had on Nam Tai's operations.

Second, I ignored the risks mentioned in the first article, specifically the risk about being invested in China. Since opening a position, several articles and blogs have come out questioning the trustworthiness of the accounting at many Chinese small-cap companies. The general atmosphere these have created has contributed to the current lower share price of Nam Tai.

As a result, purchasing additional shares at a "better" price actually increased the portfolio's risk level. In other words, my midlevel two-purchase is supposed to be for companies I feel more confident about, not for situations where I'm actually increasing the risk.

Today's situation and solution
The company has since come out with an update that there will be "minimal unfavorable impact on second quarter 2011" results and little effect for the year. While that relieves some concerns, there are still a couple remaining.

One is the sustainability of the company's dividend. For the first quarter this year, net income was $0.05 per share, the same amount as the quarterly dividend. Unless the company can grow earnings to be substantially more than the dividend payment each quarter, the dividend will almost certainly be cut or eliminated when the board next reviews it.

Another is the drop in margins reported in the first quarter. A year ago, gross margin was 8.2%, while it dropped to 5.1% this year. That was attributed to product mix, discontinuing higher gross margin products such as Bluetooth headsets, and higher labor costs. The latter two reasons seem to me to be permanent, so a lower margin is the new state of affairs. To make the same profit, lower margins require higher sales volumes, which the company managed last quarter -- 104% revenue growth year over year. But this requirement increases the risk of any economic recovery slowdown hurting the company.

Taken all together, the MUE portfolio's position in Nam Tai is too large for the risk. Therefore, tomorrow I will be selling 50 of the 105 shares the portfolio currently owns. This will be the first position purchased, leaving the portfolio with the lower cost basis shares remaining.

The reason I'm not selling the whole position is because I still consider the original thesis to be valid. Nam Tai should do well as the global recovery continues. Today's move gets me back to that position.

After you add Nam Tai to My Watchlist by clicking here, come discuss this decision and how you handle risk on my Messed-Up Expectations discussion board or follow me on Twitter.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).

Fool analyst Jim Mueller doesn't own shares of any company mentioned. He's an analyst for the Motley Fool Stock Advisor newsletter service.

The Motley Fool owns shares of Nam Tai Electronics and Motley Fool newsletter services have recommended buying shares of the company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool's disclosure policy is never messed up.


Read/Post Comments (2) | Recommend This Article (7)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 21, 2011, at 10:28 PM, Joco34 wrote:

    The japanese plants will now be outsourcing even more work to Nam Tai. What happened is actually a short term negative, but a longer term positive for the company.

    As far as trustworthiness, they have a history of paying fairly substantial dividends and that was stopped in 2008 because the company is conservative. The companies that are fraud NEVER pay dividends, if anything, they just keep raising capital or issuing debt....

    All in all, everything that has happend impacgted the stock, but has hardly changed anything longer term. The stock is almost trading at cash value, profitable, and is more likely to increase the dividend rather than cutting it. That's just my opinion but what I do know is that I never sell a value stock just because it went down because of market sentiment that doesn't change the fundamentals....

  • Report this Comment On June 22, 2011, at 1:15 PM, TMFTortoise wrote:

    Hi Joco,

    Thanks for reading and commenting.

    I tried to make clear that I wasn't selling because the price had gone down -- that's not a reason for me to sell a stock position -- but because the second purchase was a mistake given my assessment of the risks and what I am trying to do with the portfolio.

    Also, I must not have been clear with the trustworthiness comment. Didn't mean to say that I thought Nam Tai wasn't trustworthy, just that the general market sentiment because of articles questioning Chinese small caps was contributing to the lower price.

    Jim

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