That which humans collect, we have a natural urge to categorize. Books, rocks, baseball cards, whatever -- and stocks are no different. Some we classify as "growth stocks," because their revenue -- and, hopefully -- earnings are rising relatively rapidly. Others are viewed as "value stocks," because based on the fundamentals, they look underpriced. If the business has been in the habit of distributing solid, often rising dividends, it might get called an "income stock."
And then there are "story stocks" -- the ones that are trading less on their current numbers, and more on the narrative that investors and the media have built to describe why eventually, the revenue and earnings will surely arrive. Paint a compelling enough picture, and investors will bid your company up on hope and faith.
But Motley Fool co-founder David Gardner sometimes takes a different view of the "story" concept -- he prefers to think about the way occasionally, an addition to your portfolio creates a story that's unique to you, and that clarifies a specific nugget of investing wisdom.
In this episode of Rule Breaker Investing, he invites several of his colleagues into the studio to share some of their favorite "stock stories" and the lessons they learned from them. For this segment, his guest is analyst Emily Flippen, who looks back at an interesting moment in the publicly traded life of New Oriental Education (NYSE:EDU), which primarily teaches Chinese students how to speak English, and offers prep classes for various standardized tests like the SAT, GRE, and TOEFL. The business model is easy enough to understand, but Americans' fears that they couldn't trust the financial reports of Chinese companies made it quite vulnerable when a short-seller went on the attack in 2012. Vulnerable for a little while, anyway...
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.
This video was recorded on May 1, 2019.
Emily Flippen: Today, I'm going to be talking about a stock that has been a silent performer, that a lot of people, unless you are a hardcore Rule Breakers follower, may not be aware of.
David Gardner: Love it!
Flippen: It's New Oriental Education.
Gardner: New Oriental Education, yep, a stock that we recommended years ago. As you're mentioning, it's quiet. I have to admit right now, I don't know exactly where the share price is. I think it's been a quiet winner. Maybe that's part of the story. Emily, what's the title of your story?
Flippen: The title of my story is "The Super Short: A Story of Hope, Loss, and Redemption in China."
Gardner: Awesome! "The Super Short." It's like The Big Short. Is this a play on words of Michael Lewis' book?
Flippen: It's kind of like The Big Short, but hopefully it doesn't cause a recession and we all come out of it better.
Gardner: [laughs] All right. Start!
Flippen: Sure. The year is 2006, and we have a small Chinese education company come public on U.S. markets. Needless to say, the market's been doing well, the valuation looks a little lopsided in their favor, and investors are very fearful. Not just fearful because maybe this is a pricey stock for a company that just teaches Chinese people how to speak English. But, this is a Chinese company, and it's a small Chinese company.
Gardner: Lots of questions about, is this even real? Can I believe the balance sheet or the numbers? These kinds of concerns.
Flippen: Exactly! So when they come public, there's a lot of interest, but also a lot of fear. And there's a lot of people out there saying, "This is clearly a fraudulent company. If it's not just because the company is lying, inflating its numbers, it's because the Chinese government is lying and controlling the company with their back hand." It's a company that a lot of investors are extremely nervous about. And if you take the time to go back and read a lot of these articles written about New Oriental Education --
Gardner: Maybe you did that in preparation, I'm not expecting you did, that's above and beyond what we would ever expect on this podcast, because I'm most of the time just shooting from the hip and making up all my stories, in fact -- but, Emily, thank you for going back if you did, because I always think we don't do that enough in our society today. We tend to just, what's the next headline? But we learn so much by remembering what people were saying back in the day.
Flippen: Exactly! And if you go back and read these articles, which I definitely encourage anybody who's listening to do, you'll see that things were not looking great for New Oriental. There's a lot of investor fear. And despite the stock having a nice run-up from 2006 -- it did manage to survive our pullback here in the U.S. -- there was still a lot of investor fear for years leading up to this.
What happened is, in 2012, we got a short report. It was really only a matter of time before a short report on this company came out, or really any small-cap Chinese company.
Gardner: Now, when you say "short report," do you mean what I would characterize often as a short attack?
Flippen: A short attack is an aggressive way to say it, but undoubtedly. Muddy Waters reported it. Of course, they are short the stock, so they have economic interest in pushing the stock price down. But this report comes out and says some very egregious things about the company, essentially saying they're lying not only about the way they make money, but about the way they report money. They're lying to their auditors, they're lying to their investors, they're lying to the government. These are huge claims. It sends the stock plummeting.
Gardner: I remember we first recommended this stock, it was in fact pretty much this week, just about April 28th, 2010, it was nine years ago, pretty much this week. The stock was at $22 back then. Do you remember where it dropped after or around that 2012 report?
Flippen: It had just been off of its 52-week high, around $32. So, just off that high. Within a matter of days, there was an investigation into their accounting in this short report, which sent the stock down to $11.
Gardner: Wow! I had forgotten. That probably hurt. I forgot the pain I was feeling at the time, because we were up 50%, and all of a sudden, we were down 50%, from $22 down to $11.
Flippen: Exactly! And needless to say, if you look at a graph of New Oriental Education's stock price today, I dare you to even find that 50% drop. After that drop, the company went on to be a clear outperformer. Now it's at a price of about $95. I think its high was around $108. If you look at this price, it's just a 50% drop, which at the time felt like the end of the world for this company. Accounting errors, lying to the investors -- to turn around and report amazing results for years afterwards, really showing that this was just a blip in an otherwise kind of flawless radar.
Gardner: Now, Emily, those who've gotten to know you may remember that you were a Motley Fool intern in the year 2016, and now, happy ending -- a really happy beginning -- you're a full-time employee here at the Fool. But I know you spent some years in China. Did you ever see the New Oriental Education and Technology Group name or brand? Were you aware of the company when you were in China?
Flippen: I was aware of it just from a perspective of seeing it around me. I don't think it ever really occurred to me when I was there that this was a public company in the U.S., which, at the time, it was. But it was everywhere. So, hindsight looking back, you think, well, of course it's a legitimate business. I saw the people, I saw the stores, the customers, the teachers, I had friends who worked with the organization on a freelance basis. But hindsight really is 20/20. It's interesting, because while this is just one story about one stock, it can really be applied to how we're seeing Chinese companies today. Going back to reading those articles about New Oriental, I see the same things happening to many of the Chinese companies that are going public recently. There's always questions about, how much can you believe? Are they defrauding investors? Are they lying? Are they even a legitimate business in China? So, it's really funny to see how we see these same concerns rear their head over a decade later.
Gardner: What's the one-liner takeaway that you want us to remember from this story?
Flippen: I'd have to say that it's really that history repeats itself. Sometimes that's good, sometimes that's bad. But anytime you're thinking, "This is the end of the world," your stock is down 50%, remember, history shows it's not.
Gardner: New Oriental Education and Technology Group, ticker EDU, which is a pretty good description of what the business does. Even though they were a Chinese company, they were the ones who got EDU on the New York Stock Exchange. And yes, they've been operating for quite a while and very successfully, and Emily, as you mentioned, very quietly. Most people don't know that stock or company even today. And yet it's gone from $22 to around $95 as we speak today, a wonderful long-term hold, which is what we do at Motley Fool Rule Breakers and Motley Fool Stock Advisor. That's what The Motley Fool is teaching the world. Play for the only term that counts, the long term. Emily, thank you!
Flippen: Thanks for having me!