This past year was an exciting one to be an investor. At one point in March, stocks were down well more than 50% from their 2008 highs. Yet amid this chaos, we at Motley Fool Global Gains identified a promising small company with a strong and growing core business that was selling for a dirt cheap 4.5 times earnings.
Since we recommended that stock to our members in October 2008, it's returned more than 400%. During that time, it has also listed on a major exchange and vastly expanded its production and distribution capacity.
But before I get to the stock, I want to tell you how we found it, and provide a few points that can help you identify similar things for yourself.
You find what you're looking for
You may have heard (sometime, somewhere) that the market is efficient. That means that at any moment, all of the available information on a stock has been incorporated into its price. While I believe that's generally true, I don't believe it's true all the time. What's more, it's less true in certain market segments than others.
For example, take a popular U.S. megacap like Google (Nasdaq: GOOG ) . It's tracked by 43 sell-side analysts, has earned a rabid following of fans and detractors, and everything from its products to its plans to digitalize books are reported on daily in the media. This, in other words, is a stock whose price is largely efficient. If you choose to buy or sell Google stock, you're likely not doing so with any kind of informational advantage over your counterparty.
That, however, is less likely to be the case if you're buying and selling stocks that most other market participants aren't even paying attention to. Specifically, that's small stocks, foreign stocks, and especially small and foreign stocks.
Which brings me back to my story
The stock we discovered at Global Gains that's more quintupled in less than one year is a small Chinese fertilizer company called China Green Agriculture. In hindsight, at less than 5 times earnings last October, it looked like a clear winner.
The company's organic fertilizers were coming into favor as the government encouraged farmers to increase food production without a destructive environmental impact. Furthermore, government efforts to aid rural farmers were giving those farmers -- China Green's customers -- increased purchasing power. Finally, there was a clear catalyst in the new 40,000-metric-ton manufacturing facility that the company planned to open with the capital it raised in a private placement.
Yet the market either wasn't paying attention here, or it was far too focused on the perceived risks of investing in China Green Agriculture. Those included a very short track record as a public company, an over-the-counter stock listing, and no permanent CFO.
How, then, were we able to get comfortable with recommending China Green's stock?
Elementary, my dear Watson
The simple fact is that we traveled to Xi'an, China, last June, and spent two days visiting with the company and touring its R&D and production facilities. We talked extensively with management about their plans for the future and their perceived market opportunities. And we got answers to every question we had about the company.
This doesn't mean we walked away 100% confident. After all, a company visit, while an important part of our research process at Global Gains, will never reveal the full story. But the visit enabled us to get comfortable enough to recommend that our members buy shares at less than 5 times earnings within the context of a diversified portfolio.
The result speaks for itself. Not only is China Green Agriculture up more than 400%, but it's the best-performing U.S.-listed China stock, having outperformed bigger China plays such as NetEase (Nasdaq: NTES ) , Suntech Power (NYSE: STP ) , and Changyou.com (Nasdaq: CYOU ) . It's also among the top-performing stocks in the agriculture space, besting the likes of Dow Chemical (NYSE: DOW ) and Syngenta (NYSE: SYT ) by wide margins.
Your takeaway
Now, you may not have the resources to travel to China to check up on all of the small, cheap, and fast-growing companies there that you may be interested in owning. But short of that, the lesson here is that you can only take advantage of the inefficiencies that exist in the stock market by doing an extraordinary level of due diligence.
That means going through the filings with a fine-toothed comb, checking up on a company's auditor to make sure it has a good reputation, and doing extensive analysis of the numbers to make sure they're good, but not too good to be true.
Still, if you can make company visits a part of your research process, I encourage you to do so. We travel to China every year with Motley Fool Global Gains, and we've found that firsthand observation the best way to identify both the most promising ideas and the potential disasters.
In fact, we just returned from this summer's trip to China and released our top picks from the trip -- including one opportunity that's eerily similar to the one we discovered at China Green this time last year. To get the name of that stock and all of our picks, click here to join Global Gains free for 30 days.
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This article was first published on June 24, 2009 as "How We Tripled Our Money in a Year." It has been updated because China Green keeps going up.
Tim Hanson is co-advisor of Motley Fool Global Gains. He does not own shares of any company mentioned. China Green Agriculture is a Global Gains recommendation. Google, Suntech Power, and NetEase are Rule Breakers selections. The Fool's disclosure policy is Zen.
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