One Wildly Mispriced Stock You've Never Heard Of

Question: Where are the biggest stock mispricings?

The general answer is that they lie in the dark corners of the market. The places with incomplete, unreliable, or conflicting information. The places where even Wall Street analysts rarely tread.

The specific answer is smaller-cap stocks and foreign stocks.

Now imagine the mispricings that can come with smaller-cap stocks that also happen to be foreign. Don't think too hard. I've got an example that's going to blow your mind.

How these mispricings occur
Before I reveal my example, you need to understand exactly why foreign small-caps can be wildly mispriced. One of the best ways to shine light on a dark subject is to study its opposite, and the opposite of a foreign small cap is an American large-cap stock.

When we talk about the prospects of an American large cap, we take a lot of things for granted, including:

  • Firsthand knowledge.
  • Safety in watchdog numbers.
  • System stability.
  • Track record.

Let me briefly explain.

Firsthand knowledge
Even folks who aren't tech-savvy can verify some of the claims AMD (NYSE: AMD  ) and Intel (Nasdaq: INTC  ) make. Per their income statements, Intel has more than six times the sales of AMD; as a very rudimentary sniff test, we can walk into a Best Buy and physically see the computers with "Intel Inside" stickers and compare them to the number of AMD-based computers.

Another income statement example: Intel's R&D budget is the same size as AMD's total sales, traditionally giving Intel a rare moat in the technology space. But with technology, advances aren't always correlated with R&D spend. AMD bulls are banking on AMD doing more with less. As investors trying to compare the prospects of their technologies, there is a wealth of credible information out there on numerous tech sites. That's not true for many foreign large caps, much less foreign small caps.

Safety in watchdog numbers
In the U.S. markets, we have the Securities and Exchange Commission and major stock exchanges like the NYSE and Nasdaq setting stringent reporting requirements and keeping watch.

Meanwhile, we get ample (if short-term-focused) analysis from Wall Street analysts. A famous stock like Disney (NYSE: DIS  ) has 31 Wall Street analysts following it. A less famous but just as big company like oilfield services provider Schlumberger (NYSE: SLB  ) has 32, while a smaller but popular stock like Netflix (Nasdaq: NFLX  ) has 33.

With safeguards like watchdog agencies and focused analysts in place, we have some assurance that past earnings are trustworthy. When we look at trailing earnings multiples (price-to-earnings ratios of 18, 28, 46 for Disney, Schlumberger, and Netflix, respectively), we can focus on whether those valuations are expensive rather than whether they're fraudulent.

We can combine the trailing and forward earnings multiples estimates (15, 17, 30 for Disney, Schlumberger, and Netflix, respectively) with key drivers (e.g., the Marvel acquisition for Disney, the growth of the oil and gas industry for Schlumberger, and the rise of video on demand for Netflix) to generate reasonable going-in positions on the companies.

For example, given the multiples, I'd be looking to make sure Disney and Schlumberger could defend and moderately grow their earnings. I'd also be looking to see if Netflix could not only defend itself against the decline of DVDs but also substantially grow its earnings.

Even with all these watchdogs in place, though, due diligence on these going-in positions is required. Fudged financials and outright fraud slip through the cracks ... but imagine how bad it could get when no one's watching.

System stability
The U.S. is about as good as it gets in terms of providing a safe environment for capitalism to operate. Management doesn't have to spend too much time fretting about the threat of civil unrest, a government arbitrarily enforcing property rights, or the illegal activities of competitors.

That's not necessarily the case for a foreign company, large or small.

Track record
No matter what you think of the investing thesis behind Disney, Schlumberger, and Netflix, these large U.S. stocks have verifiable track records. Disney, for example, was founded in the 1920s and went public in the 1960s.

Many foreign small caps have problems with both the "verifiable" and the "track record" parts of that request.

So why invest in a foreign small cap?
At this point you may be forgetting why anyone would invest in a small foreign company. Let me remind you. For those investors with a competitive advantage, there are serious opportunities to rake in outsized returns due to stock mispricings.

Let me give you an example.

The company is called China Marine Food Group (AMEX: CMFO  ) . It sells salty seafood snacks like dried squid and barbecued sleeve fish.

To the average sane American investor, this sounds (1) gross and (2) not worth further research. But Motley Fool Global Gains co-advisor Tim Hanson would disagree on both counts. These snacks won't play in Peoria, but Tim notes that "they're basically the Chinese equivalent of potato chips." And boy is he glad he investigated further.

He found a company trading for a P/E ratio under 5, but after backing out the cash, the multiple was just 1.7 times earnings -- for a stock expecting more than 20% top-line growth.

If you've been following along, you can probably guess why it was so cheap: It's a very small Chinese company that makes questionable-sounding snacks. It operates in a country known for its government interference, not its corporate governance. Kraft this ain't, folks.  

So is China Marine Food Group a buy?
As part of his duties as Global Gains co-advisor, Tim supplements the knowledge he gains at investor conferences with trips around the world. On his trips to China, for example, he meets with companies' management and tours their facilities. These meetings not only allow him to vet specific stock picks, but also allow him to compare and contrast companies, industries, and countries.

This on-the-ground experience is why he judged the risk to be worth the potential reward on China Marine Food Group when he recommended it back in May 2009. It's gone up over 140% since then, so it no longer trades at that 1.7-times earnings figure -- but Tim still rates the company a "Best Buy."

For a Chinese pick that hasn't run up, check out Guangshen Railway (NYSE: GSH  ) . It's currently trading for less than its tangible book value. That's exceedingly cheap for a capital-intensive business. You can see Tim's full analysis on Guangshen as well as his insights from his most recent scouting trip to Greece with a free, 30-day Global Gains guest membership. Just click here to get started.

Anand Chokkavelu owns shares of Disney. China Marine Food Group and Guangshen Railway are Motley Fool Global Gains picks. Walt Disney, Best Buy, and Intel are Inside Value choices. Walt Disney, Best Buy, and Netflix are Stock Advisor recommendations. The Fool has created a covered strangle position on Intel. Motley Fool Options has recommended a buy calls position on Intel and a bull call spread on Best Buy. The Fool owns shares of Best Buy and has a disclosure policy.


Read/Post Comments (24) | Recommend This Article (123)

Comments from our Foolish Readers

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 May 18, 2010, at 4:41 PM, uncas10 wrote:

    hi , sooooo where is the rec. ?? ..... a lot of reading and more than 1 stock mentioned and i'm confused ... do i have to be a paid subscriber ??

  • Report this Comment On May 18, 2010, at 6:35 PM, tomd728 wrote:

    A subscription to MFGG wouldn't hurt if you want

    to find undervalued, overlooked, successful companies in places where few go.

    If not simply do your own DD on CMFO & GSH.

    Sounds like a freebie to me.

    Everyone and their brother has an opinion on DIS,NFLX, etc.etc. Then again we already know about those outfits as going concerns and in the news daily.

    In any event.....Good Investing to you !

    Tom

  • Report this Comment On May 18, 2010, at 8:28 PM, hooooon wrote:

    is this a joke? there are dozens of chinese stocks with single digit p/es in far more attractive industries: CBEH, UTA, SRRY.OB....

  • Report this Comment On May 19, 2010, at 7:43 AM, kayakmastr wrote:

    Joke? Why not learn more about cmfo and compare with the others? Then share your insights.

  • Report this Comment On May 19, 2010, at 2:04 PM, grant224 wrote:

    I wonder if Tim Hanson actually tried the snacks while visiting China? I bet he would like them.. and if not that may be something else to consider..

  • Report this Comment On May 19, 2010, at 3:16 PM, TMFBomb wrote:

    @grant224,

    Here's an excerpt from when Tim re-rec'd CMFO in December:

    The taste-test results are in, and the Global Gains members who summoned up the courage to sample some of China Marine Food Group's (AMEX: CMFO) squid snacks were generally pretty happy they did.

    -Anand

  • Report this Comment On May 20, 2010, at 12:10 PM, mikecart1 wrote:

    This is the worst article of all time - of all TIME!

  • Report this Comment On May 20, 2010, at 12:34 PM, MaxPower13 wrote:

    Wow. I feel very privileged to know I just read the worst article of all time - of all TIME! Wait'll I tell the kids. My co-workers will be quite impressed as well.

  • Report this Comment On May 20, 2010, at 9:51 PM, TMFBomb wrote:

    @MaxPower13,

    Imagine the amount of pride you'd have if you wrote it!

    -Anand

  • Report this Comment On May 21, 2010, at 2:33 AM, TheGarcipian wrote:

    Pretty funny, Anand. Liked the article (especially being the worst of ALL time), but I don't follow the claims here. According to Yahoo! Finance, the best/lowest price you could have possibly purchased CMFO was on June 23, 2009 at an intra-day price of $3.20/share. Given today's close of $5.59, that's only a 75% rise. If you were using yesterday's close of $5.89, that still only adds up to an 84% jump. While those are great numbers, they're far from the 140% gain claimed in the article above. And that's with absolutely the best cherry-picking happening, nailing the low for June 2009 with an intra-day trade. Not likely to occur for Joe Investor...

    I realize you're trying to sell paper (and I do appreciate the free advice in the article), but I'm just trying to keep TMF honest with their numbers. So how did you come up with that number? Are you comparing the absolute June 2009 low with the absolute recent high, which occurred way back on January 6, 2010? Just curious...

  • Report this Comment On May 21, 2010, at 12:44 PM, Racovius wrote:

    invest in what you know. and i know my dried seafood pretty well actually. western tastes can't handle it, well that's too bad.

  • Report this Comment On May 21, 2010, at 1:45 PM, dwitiya wrote:

    The Garcipian writes " Are you comparing the absolute June 2009 low with the absolute recent high, which occurred way back on January 6,2010? Just curious..."

    --- Ofcourse, that is how Motley Fool and most other Financial Newsletters boost their claims, and cheat Joe Public. If you had been following Motley Fool, you should have known that by now.

  • Report this Comment On May 21, 2010, at 2:11 PM, ankateif wrote:

    So what you dont need to know the market to make profit. None of the american analysts that get on CNN has any idea about the greek culture and still they managed to do what they wanted in that market.

    http;//ankateif.blogspot.com

  • Report this Comment On May 21, 2010, at 4:17 PM, PKChang wrote:

    It is fascinating, if somewhat depressing, to see how some comments completely miss the point of an article. If you can not remember the following, please don't consider investing in 'foreign' companies: high growth market opportunities ALWAYS offer more risk than more stable options; it is IMPERATIVE that you do your own research; and cash is ALWAYS king, even in communist countries.

  • Report this Comment On May 21, 2010, at 5:20 PM, TMFBomb wrote:

    @ TheGarcipian,

    Thanks for the kind words. Thank you moreso for keeping me on my toes.

    I referenced the Global Gains recommendation of CMFO in June 2009...our newsletter issues are actually released sometime in the calendar month before...so the June 2009 issue of Global Gains was released in May 2009, when prices for CMFO were lower.

    The price at the time of rec was $2.42...as I write this comment, it is up 132%.

    I changed the "June 2009" reference to "May 2009" so no one gets confused...thanks for the eagle eyes!

    -Anand

  • Report this Comment On May 21, 2010, at 5:35 PM, FUDweiser wrote:

    Stay away from China stock! Rationale, trends, fundamentals --nothing apply there. I have been burned twice. Global gains and hidden gems are sub par MF services.

  • Report this Comment On May 21, 2010, at 7:27 PM, Tirelli wrote:

    well...so far all of FOOL recomandations...have fooled me...in 1 month...so I really feal like a FOOL

  • Report this Comment On May 22, 2010, at 3:25 AM, RockderktheGreat wrote:

    This is the crap you get when you accept emails from friends of the Motley Fool. You just go to the last couple o paragraphs and find ...Oh, there it is! Guangshen railway, and oh, the writer owns it and wants us to buy it too...Hmmmm...Nice try Anand. Even if Kim Jong Il plans to start commuting to Beijing on the Guangshen Express, you won't catch me investing in a Chinese railway, or anything else Chinese for that matter. That is, until the Politburo stop stifling free speech, jailing political opposition, building dams along the Mekong without consulting the nations which depend on its water, manipulating their currency, supporting Kim Jong Il, oppressing Tibetans and Uighurs, supporting African dictatorships, generally feeding dis-information to their people and having a leader who looks like a friggin automaton.

  • Report this Comment On May 22, 2010, at 7:00 PM, philkek wrote:

    American Better Business Bureau has a motto: "Investigate BEFORE you invest". Or, as MF tells us fools, DO your homework. This homework should apply to ALL investing, American and foreign. I believe SOME of us will be laughing -ha-ha- all the way to the bank. Fool on.

  • Report this Comment On May 22, 2010, at 10:50 PM, JDTroit wrote:

    Unfortunately, philkek, for most of us who foolishly follow along with hard-held losses- we donot laugh so much.

  • Report this Comment On May 23, 2010, at 12:05 AM, jbnow wrote:

    AAPL. Apple, In late winter or spring of 2009 Apple was at around $89. Apple has a reasonably strong daily trading volume. Apple is now at about $240. The PE is still modest. That's approximately x2.5 gain. But by golly don't go out and buy apple now and expect it to go up another x2.5. I am multiyear subscriber to Motley Fool. However, I don't recall an AAPL buy recommendation during that low in AAPL stock price. (later they recommended it) However, AAPL bought at that time would have been a good buy. (NATI would have been another) In many ways learning to select stocks takes time and practice. Choosing stocks that provide a solid trading volume and substantial gains (like AAPL did) in the same time period is not easy. I've lost considerable amount of money in buying Motley Fool recommendations, however I've made a great deal more money in learning from those losses, and in selecting better stocks.

    1. Buy stocks with large enough daily trading volume that you will be able to cash out when needed. $25,000 dollars in AAPL may be a lot easier to sell than $25,000 in a low volume traded stock, particularly in a declining market where you still have some profit to take out of the stock.

    2. Look for real value. Look at the balance sheet and compare Cash to Total Debt. Re-read the previous sentence and think about what that means. Be very cautious about companies that are strapped with debt. Be very cautious about companies that appear to have a lot of cash and very little debt. That's right some companies structure there balances sheets to make them look good.

    3. The various Motley Fool newsletters make many recommendations. (There was a million dollar portfolio that lost considerable money in the last few years and this was one of Motley Fools premier flagships... you won't hear or see about that Fiasco published on the Fools website.) As a young investor or an investor with little cash you will NOT have enough cash to take advantage of all the recommendations. So don't be foolish. You need to be very, very carful with your hard earned money.

    4. If you do subscribe to a motley fool news letter consider it like taking a self improvement course or a college course in finance and investing. You're going to learn many important lessons, but only if you a) Don't kid yourself, b) Pay attention. Don't invest any money you can't afford to lose!!!!!

    5. Read, read, read from all of the posts about losses. Learn how to avoid these before you put money in the market. Pay attention to a select few industries. Take advantage of the free Motley Fool services called CAPS. By far the greatest tool there is on the fool.

    6. Goodness go out an buy used copies of Peter Lynch's books from Amazon, or visit a library and borrow or read them from the library... a much less expensive way to learn about the market than a Motley Fool Subscription.

    7. Learn how to read a financial statement and investigate a true value of a company and an upcoming trend.

  • Report this Comment On May 23, 2010, at 7:53 AM, AmarKap wrote:

    @jbnow: Wow...thank you for all those points! I think your posting should be required reading for every person who joins fool.com. That is amazing compilation. I must confess I violated a few of them myself but it is what it is. Regardless, thank you for the advice to all new investors (even existing ought to be reminded of the basic tenets outlined in your post).

  • Report this Comment On May 23, 2010, at 8:12 AM, ragedmaximus wrote:

    first of all I would not invest in china unless it was bidu and secondly a snack co. that sells bait? anyways I was wondering If I had a MILLION dollars and was invested in MF million dollar portfolio service would I be down like 250k right now?

  • Report this Comment On September 16, 2010, at 1:29 PM, rav55 wrote:

    When is everyone going to realise that Motley Fool just makes noise to get eyeballs to their website to make money on the advertising?

    They don't say anything wothwhile because in any given day they'll contradict themselves.

    A perfect example is their new short selling blah-blah-blahg.

    Short selling is not investing because you don't buy or INVEST in a security. You borrow it and sell it. So you make or loose money on your obligation NOT on your investment.

    Motley just throws words.

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