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 200%. During that time, it has also listed on a major exchange and vastly expanded its production and distribution capacity. Thus, even though it's not quite the deal we got back in October, the stock remains on our Best Buys list.
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 Microsoft
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 than tripled 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. Further, 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.
And the result speaks for itself. Not only is it up more than 200%, but it's outperformed other well-known China plays, such as China Life Insurance
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 is that the only way you're going to be able to take advantage of the inefficiencies that exist in the stock market is 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.
Yet if you can make company visits a part of your research process, I encourage you to do so. We travel to China each and every year with Motley Fool Global Gains and have found that it's the best way to identify both the most promising ideas as well as 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. It has been updated.
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. Microsoft is an Inside Value pick. Shanda is a Rule Breakers selection. The Fool's disclosure policy is Zen.