If you still haven't had enough of China after the recent Shanda
First-quarter numbers showed amazing gains over Q1 2004. Revenues shot up 138% and net income jumped 115%. More design contracts and royalty fees have pushed year-to-date net income to $23 million, giving the stock a price-to-earnings ratio (P/E) of 35. This multiple looks very low considering the company's growth.
But there's more to valuing this stock than determining a set growth rate. There are plenty of risks to consider. Is management shareholder-friendly or will it overpay for an acquisition? What could happen to margins if economic conditions change? These questions are hard to answer, because the company is just 3 years old. With very little past data to consider, the risk of using guesswork in valuation estimates increases.
Another risk is China itself. Here, it's more important to focus on the potential downside than the exciting economic forecasts. How will different currencies, governments, and legal systems affect the underlying business value?
Last, but not least, is the cash-constricting risk of competition, which technology amplifies considerably. Tech Faith must constantly make bids, year after year, to obtain design contracts. If the competition decides to cut prices or finds a more lucrative tech idea, TechFaith's earnings will suffer.
These risks knock out most investors' chances of predicting reasonable future cash flows. And if you can't do that, it's speculating, not investing. However, some investors may make time to do extra research -- given the seemingly low P/E. If TechFaith's high growth rate continues, the work could be well rewarded. The starting point would be thorough research of the company's competitive position and customers. It would also help to study design outsourcing trends, technological innovations, and China's business environment.
But that's tough research. For most of us, finding value in a simple business with good economics just makes more sense.
Finding an undervalued business with good economics is tough. Luckily, our very own Philip Durell has made a career out of it. Sign up for a free trial of Motley Fool Inside Value to see his two current recommendations.
Fool contributor Matt Thurmond owns no shares in any company mentioned in this article.