How do you know if you've happened upon an overlooked and therefore potentially undervalued stock? How about when the popular financial press mocks you for owning it. That's precisely what happened yesterday when George Soros disclosed a greater than 5% position in tiny Female Health Co. (Nasdaq: FHCO ) , a Chicago-based maker of female condoms.
The Wall Street Journal's MarketBeat blog, for example, mused that while Soros's purchase of Platinum Group Metals (NYSE: PLG ) made some sense given his position on gold, when it came to Female Health, "we have no idea." Taking it to the next level was the always sarcastic (and therefore mostly annoying) Bess Levin of Dealbreaker. She wrote, "Personally, never have I ever heard of a single person who’s even once used a female condom, even as a joke, but leave it to the Don Juan of the hedge fund world to be consistently ahead of the sexual trends curve." That blog's commenters demonstrated a similar lack of understanding of Female Health's product or its market opportunity.
Good news for the rest of us
One of the most famous sayings in the investing world is the Peter Lynch's advice to "Buy what you know." This makes sense because familiarity with a product can help investors better analyze and anticipate a company's success. A consequence of this advice, however, is that companies that make products people don't know end up getting overlooked and therefore undervalued. In fact, Peter Lynch is famous for pointing out this phenomenon as well. When he describes the "perfect stock" in One Up On Wall Street, for example, he names at least three attributes that describe Female Health:
1. It sounds dull -- or even better, ridiculous.
2. The institutions don't own it, and the analysts don't follow it.
3. It's got a niche.
We know thanks to MarketBeat and Dealbreaker how Female Health sounds to observers, so there's no debating that. We also know that the stock has just 13% institutional ownership and just two analysts follow the company. And as for its niche, well, that's what makes Female Health such an interesting investment opportunity today.
Be successful somewhere
Although Female Health isn't apparently selling much product to U.S.-based financial bloggers or their friends, the company has more than doubled its sales over the past five years. The reason is that Female Health makes a significant and growing amount of sales (more than half in 2009) to Africa, and particularly to the countries of South Africa, Zimbabwe, Congo, Tanzania, and Zambia.
That's because Female Health's most important market opportunity today is in helping prevent the spread of AIDS in places such as Africa where infection rates are high, the sex trade is prevalent, and men often resist using condoms. The reason is that female condoms, unlike male condoms, can be put in place ahead of time and solely at a woman's discretion -- key features given the context there. This is why aid groups such as the U.S. Agency for International Development and World Health Organization are buying Female Health's products and subsidizing their distribution (female condoms are quite a bit more expensive than their male counterparts).
Given the global commitment to fighting AIDS and the fact that female condoms represented just 0.5% of all condoms distributed in 2008, I expect Female Health's sales volumes to continue increasing at a better than 20% clip. Add to that the fact that the company should be more profitable following the transition from making a first-generation latex product to a second-generation nitrile polymer product, a debt-free balance sheet, and a near-4% dividend yield, and the reasons why Soros owns the stock -- and why we recommended it in Motley Fool Global Gains -- become pretty obvious to anyone who takes just a few moments to think about it. That profile also makes Female Health a potential takeover candidate for a global consumer products company such as Reckitt Benckiser, which recently acquired SSL International, the maker of Durex condoms, or Church & Dwight (NYSE: CHD ) , which owns the Trojan brand.
The global view
Misunderstanding is one cause of mispricing in the stock market. The reality that Female Health is misunderstood by U.S. investors because a female condom is not all that popular here in the U.S. is one reason we, like George Soros, have found an opportunity in the stock. Yet Female Health is not the market's only misunderstood stock, and one of the best frameworks an investor can use today to find mispriced misunderstandings is a global one.
Take, for example, the case of Yahoo! (Nasdaq: YHOO ) . Despite the fact that analysts seem to believe that more than half of Yahoo!'s value today lies in its cash and investments, including a 40% stake in China's Alibaba Group, those same analysts, at least in the reports I've read, spend 99% of their time and effort dissecting Yahoo!'s U.S. business and just accept the market values of Yahoo! Japan and Alibaba.com or simply slap a multiple on their revenue. That makes no sense, and I suspect that if those analysts took a global view and analyzed closely-held Alibaba Group in more depth, they might discover that Yahoo!'s stake has the potential to be worth much more.
Yet most U.S. investors simply don't have the time, patience, or knowledge to come to an understanding of a company's global context. That creates opportunity for the investors who do, and I believe those opportunities exist at both small, underfollowed companies such as Female Health as well as at large, ostensibly over-followed companies such as Yahoo!
Get Tim Hanson's "Global View" column every Thursday on Fool.com or by following him on Twitter.
RSS Headlines
Fool UK