What's the worst feeling in the world for a stock analyst? To watch a stock you were about to tell people to buy rise 25% before you had a chance to tell anybody to buy it.
But that was precisely what happened to our team last week as we were picking stocks for today's brand-new issue of Motley Fool Global Gains. Here's how it went down …
Your behind-the-scenes look
Although my job is to know China stocks cold, Winner Medical (AMEX: WWIN ) was never one I paid too much attention to. It's an export-oriented manufacturer of medical cloths (used in gauze, gowns, and the like), and I assumed it was a low-margin commodity business that would see its cost advantages erode as the Chinese RMB inevitably strengthened against other world currencies.
Johnson & Johnson (NYSE: JNJ ) , after all, has the Band-Aid brand locked up, and you as a consumer don't much care about who supplies the materials for generic Walgreen (NYSE: WAG ) and CVS Caremark (NYSE: CVS ) products as long as the price is right. Further, big companies such as Walgreen and CVS drive hard bargains with their small suppliers and often play them off against each other in order to preserve their own profit margins. That's what gives these big chains economies of scale and what should make something like Winner Medical an unattractive investment.
In other words, we're talking narrow margins, limited growth opportunities, high capital requirements, and no moat. That's any investor's definition of a bad business.
A better idea
What we prefer instead at Global Gains when it comes to China are companies that are serving China's fast-growing domestic market and developing brands along the way that will give them long-term pricing power.
The ultimate success stories in this regard -- though both are very expensive now -- are Chinese Internet search giant Baidu.com (Nasdaq: BIDU ) and English-language education provider New Oriental Education (NYSE: EDU ) . Both of these companies are serving fast-growing markets in China, are among the country's best-known brands (besting foreign competitors such as Google (Nasdaq: GOOG ) ), and have more than tripled since going public in 2005 and 2006, respectively.
At first glance, Winner Medical doesn't have anything in common with these companies. But as we discovered in investigating the company further, it will soon.
Winner is no loser
In order to understand Winner's opportunity, you need a little bit of background about recent developments in China's health-care sector. The Chinese government is executing a three-year, $124 billion plan to improve and expand basic health care.
Action items include basic health insurance for 90% of the population by 2011, a nearly $20-per-person annual health subsidy for rural Chinese, 29,000 new rural health clinics, 5,000 rural health centers, 3,700 urban health centers, and 2,000 new county hospitals.
These measures are expected to dramatically increase the demand for health care, and health-care consulting firm Scientia Advisors estimates that China's annual spending on health care will more than triple to $600 billion by 2015.
What this all adds up to is massive increased demand for basic health-care supplies such as sterile gauze and dressing pads, hospital gowns, and doctor facemasks -- all items Winner manufactures and distributes through hospitals, clinics, and retail drug stores in China.
Further, Winner is investing heavily in promoting its brand to Chinese consumers. Finally, the company has patented a new material called PurCotton that not only delivers higher gross margins to the company but combines the functional benefits of synthetic materials with the lower cost of cotton.
Given these traits, we expect Winner's domestic China business to take off over the next few years, resulting in rapidly rising sales and profits and we were prepared to recommend the stock to our Global Gains members. Unfortunately, it rose 25% before we were able to do so.
Why not buy it anyway?
While we expect Winner's growth to be impressive, we also expect that it will consume significant amounts of capital -- a suspicion confirmed by the company's recent filing of a $50 million shelf registration. Further, competition should cause some margin erosion over the long term. As a result, there are limits to what we'll pay to own the stock, and today's price has exceeded that limit.
That's the bad news. The good news is that we now have a promising candidate on our watch list (and one you should add to your list as well).
We also ended up picking a stock for today's issue that offers a similar compelling business case together with a very compelling valuation. To get the details on that stock, click here to get a free Global Gains guest membership. There's no obligation to subscribe.
Tim Hanson is co-advisor of Motley Fool Global Gains. He does not own shares of any company mentioned in this story. Baidu and Google are Motley Fool Rule Breakers choices. Johnson & Johnson is an Income Investor recommendation. Motley Fool Options has recommended buying calls on Johnson & Johnson. The Fool's disclosure policy is also a winner.
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