Opportunities In Out-of-favour Stocks

DISCLAIMER:  This is not a call to buy out-of-favor stocks but to share information with fellow investors especially those who are not averse to investing in stocks of out-of-favor sector.  Managing risks is an integral part of investment success and the onus is on each one to do his/her homework and manage his/her own risks well. “No Risk No Gain; Higher Risk Higher Gain” as the saying goes. Stock investment has unforeseen risks as the stock market is irrational e.g.
Good news, share price up – that ‘s logical !
(Occasionally) Good news, share price down - that ‘s illogical but true !     Because …….
STOCK MARKET IS THE NAME
DECEPTION IS THE GAME
WHEN WHAT YOU SEE IS NOT WHAT YOU GET
YOU’VE BEEN FOOLED, ONCE AGAIN.
                                *                              *                              *                              *
From time to time, certain sectors of the market will lose favour with investors because of business downturn, economic recession, poor corporate governance, scandals, etc. Presently, the S-chips and oil & gas sectors are 2 examples.
 
Interestingly, history has shown that it is only a question of time before an out-of-favour sector would come back into favour again. How would this happened and could an investor capitalized on such a situation to make a “killing” in the market? The answer appears to be  “YES” and “NO”.
 
“YES” for those who do their homework and are patient and astute enough to move ahead of the crowd.
“NO” for those who just follow the herd’s instinct and only believe in what they see and hear
 
Looking back to the past, many stocks in out-of-favour sector normally would sell at very low valuation for considerable period of time. A time would then come when the fundamentals of some of these stocks started to improve causing them to be very grossly undervalued and to catch the eyes of some astute investors. Since these stocks are already at very low valuation, its share price had little downside and can only move sideways or up. When their share prices had appreciated substantially to give their shareholders a large windfall, the “fearful” investors on the sideline could only watch with disbelief and envy. Soon any painful experience that many of them had encuntered in the past would start to be forgotten and whatever fearfulness they might still have of such stocks gradually dissipated. Instead, fear of missing out on opportunities to make money began to dominate their emotion.
 
S-Chips Sector As Example
History will repeat itself because of the unchanging behaviour of the market along with its participants. I believe it won't be long before the S-chips make a come back since too many people have been avoiding them because of their poor corporate governance and that many had been badly burnt by them. This has resulted in their very depressed share prices and valuation. As not all s-chips are rotten, the recovery of many businesses in China after the fallout of US housing & financial crisis, have seen many China stocks making significant recovery in their profits lately - Sunvic and Bright World are 2 good examples.
 
It just need a few of the China stocks to make a spectacular recovery in their share prices giving a dramatic windfall to those brave enough to collect them at the "depression time" prices. This would then make the "herd" envious and have the effect of transforming their FEAR into one of "GREED". It had happened in previous market cycles and appears destined to happen again. Right now there are already signs of S-chips slowly making a come back in their share prices after many of them reported significantly improved business & results. The "herd" is well aware that blue chips with dividends are always the safest bet & this belief is supporting well their high stock valuation as compared to the many “potato chips” selling at a fraction of the prices for the same PEs. However, capital gains in blue chips appear rather limited making them less rewarding due to their high valuation.
 
In the last bull market of 2002 to 2007, S-chips were noted to have fallen out of favor with the "herd", after the scandal of CAO in 2004. They then made a dramatic recovery some time later & then went out of favor again after 2007 when the bear market and US financial crisis set in. Since then, this sector has remained out of favour with investors. Below is an extract of a report of S-chips' reception over the past few years taken from The Edge Malaysia, Issue 757 (June 2009) -
 
"The S-chips were investors’ darlings in 2006 when China started to open its doors, allowing domestic investment funds — which are called Qualified Domestic Institutional Investors (QDII) — to invest abroad. The Chinese government had set a quota of US$14 billion (RM49 billion) for such funds to be invested overseas.
Investors were shovelling money into S-chips on the expectation that these counters would be the priority choice of China’s QDII funds too.
The enthusiasm faded when the earnings of these companies fell short of expectations, compounded by the start of the downturn. The S-chips have now fallen out of favour among investors, and many have had their fingers badly burnt when share prices tanked as accounting fraud and bankruptcies started happening.
Oriental Century Ltd, China Sun Bio-Chem Technology Group Company and Fibrechem Technologies Ltd are among those that have been hit by alleged accounting irregularities. FerroChina Ltd has halted production in China and filed for bankruptcy. The steelmaker is facing 206 lawsuits from creditors that are claiming RMB4.82 billion (RM2.5 billion).
There is a growing fear that some companies will just vanish into thin air when their inflated sales figures, empty coffers and huge debts come to light as the crisis continues to bite.
“The rosy picture that the management had painted earlier has now been proven wrong. Investors are wary of the S-chips as it is so difficult to judge which are the good ones and which are black sheep,” says a fund manager in Singapore.
“Fund managers visited their plants and offices in China, met the management regularly, and made other checks. In the end, some still turned out to be con jobs. Many investors have decided not to touch the S-chips to avoid the risks,” he adds."
 
The stock market alternates between BULL & BEAR while the "herd" alternates between FEAR & GREED. Investment is about managing one's risks. Risks are very much lower in a bull market than a bear market and history has shown that corporate failures and scandals occurred mostly during an economic downturn along with a bear market. There is a time for all things – a time to sow, a time to reap; a time to BUY and a time to SELL.  TO EACH HIS OWN.

I agree with you - history always repeat itself at some point. It's a matter of being patient for the tide to turn in our favour. However, we should do our best to pick stocks not only for low PE and other metrics but also those that can make it back from hell.

This is where the greatest challenge lies. Once that can be achieved, the rest is a matter of waiting.

What S-chips would be on your radar screen for multi-baggers (or at least 50% return)?
I think China Goaxian (PE less than 3), Fuxing (net cash exceeds stock price) and Combine Will (dual listing in Korea) are good bets.

Ya, I nibble at combine will at 18.5cts a few mths ago-11 lots only. I am building up my position in Lafe Corporation gradually, in anticipation of its Emerald Hill project, end of this yr, completion. I have hold shares in Lafe Tech for yrs. Hope that its properties foray will bear fruits for me.

Multi-baggers are rare and difficult to find. I prefer to look for what I would consider “growth” stocks with low valuation and have a high probability of doubling in its share price within 12 months.  They are a lot easier to find and the returns are similar to multi-baggers except that it takes 2 “rounds” (or a repeat exercise) to achieve the same objective.  Assuming one bought such a stock using 100K and the stock performed to expectation. The original capital of $100K would grow to 200K at the end of round one and then to $400K after round 2 – a nett gain of $300K or 300%.
Question: Is this a realistic or achievable expectation?  The answer is certainly –
YES – For those who have a positive mindset, willing to do their homework and take calculated risks. 
NO – For those who have a negative mindset and always ready to give all the reasons why it could not or should not be done.
My stock picks for doubling this season are Qingmei (av. entry price 21.5 cts) and PEC  (av. entry price 78 cts); both accumulated as core holdings in June/July when –
1.       Many were worrying over the EU financial crisis, the possibility of double dip recession, US economy faltering, China asset bubble; etc.
2.       Market sentiment was poor & some analysts were forecasting a good pullback in the STI or a weak or lackluster 2H 2010. Investors were also advised to reduce exposure to stocks and hold more cash as market would likely go south..
3.       Prices & valuation of many penny stocks remained depressed even though some of them reported much improved results
On looking back, that period of time seemed to be excellent for accumulating good fundamentally sound stocks especially those in out-of-favour sectors. Their downside was considered extremely low since their prices could not be depressed any further & they had not gone "kaput" through "depession time" till then.
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[yeh 20-09-2010]:

I agree with you - history always repeat itself at some point. It's a matter of being patient for the tide to turn in our favour. However, we should do our best to pick stocks not only for low PE and other metrics but also those that can make it back from hell.

This is where the greatest challenge lies. Once that can be achieved, the rest is a matter of waiting.

What S-chips would be on your radar screen for multi-baggers (or at least 50% return)?
I think China Goaxian (PE less than 3), Fuxing (net cash exceeds stock price) and Combine Will (dual listing in Korea) are good bets.

History is repeating itself.  Below are extracts of commentaries from Money Markets page of Straits Times, Wednesday, 29 September 2010.
“Resurgence in activity in Singapore has been driven partly by large numbers of retail investors snapping up any promising counters in sight for fear of missing out on the rebound.”
““Retail investors are coming back into the market. China stocks are taking turns in rotational plays,” said UOB Kay Hian remiser Charlie Lim.”
“”The bulls are back. No doubts about it. Even the disbelievers are throwing caution to the wind and jumping into the fray,” said trader Peter Ong.”
““Now the easy money has been made, investors my want to keep a lookout for these undervalued gems,” it said”
Also in BUSINESS page of TODAY, Wednesday, 29 Sep 2010, it was reported that -
"The benchmark Straits Times (STI) could hit a record 4,000 points by the end of 2012, underpinned by strong growth in corporate earnings as the economic recovery gathers steam, some analysts say.
Companies are expected to report record earnings in the next 2 years, with earnings here forecast to rise about 8.9% next year and 9.8% in 2012, according to unit trusts distributor, Fundsupermart.com."

Excellent bull market is coming up.
The Dow is revving ahead - that's a strong cue of the good times to come.
It's buy and hold now : no sell : Patience will bring rewards