When Stocks Go Over the Falls
Raising a Glass to China
The big fear for people investing in growth stocks is that a stock can just blow up.
We call this “falling out of bed,” or “falling off the end of the dock” or a couple of other very colorful phrases that I can’t really write here.
This kind of huge correction usually occurs during earnings season after a company has disappointed investors with its earnings, its revenues or its forecast for future growth.
But sometimes a stock can get kicked in the head by an adverse report from an analyst.
That just happened to one stock I’ve been recommending in the Cabot China & Emerging Markets Report, and it’s a very frustrating experience, but one that offers some lessons about growth investing.
The stock is China Agritech (CAGC), a Chinese manufacturer of organic fertilizer. The stock took a 16% dive on Wednesday after it was downgraded from Hold to Sell by Chardan Capital Markets, a New York-based boutique investment bank.
What really hurt the stock was that the downgrade message cited “China Agritech’s auditor history” as one of the reasons for the action.
Now, if you know nothing else about the stock market, you should know that any message about a stock that includes the word “auditor” in it is a huge red flag for investors. Mentioning auditing raises fears of Enron-style misstatement of earnings, cooked books, fraud, and a whole swamp full of unsettling possibilities.
When investors see a warning about auditing, they head for the exit. And that’s just what happened with CAGC.
China Agritech responded quickly to the implication that something was wrong with their accounting, stating their confidence that they would meet their revenue and earnings forecasts for the year. They also said they would hire a big-name auditing firm to reassure investors about the quality of their earnings and the reliability of their reporting.
I got lots of messages from my subscribers asking about the stock during the day, and I put out a Special Hotline recommending selling the stock after the market closed.
In the end, my sell of CAGC had very little to do with the truth or falsity of the allegations or the credibility of Chardan. I reacted simply to the action of the stock.
Personally, I think it’s quite possible that the analyst who downgraded CAGC may be wrong about the company’s auditing and prospects. Partly this is because I got to look the company’s CFO in the eye at a recent investing conference and partly it’s because the language of the downgrade was pretty weasel-y, implying a lot more than it gave evidence for.
But there’s no arguing with a big selloff that indicates a change of investors’ opinions about a stock. It typically takes weeks or months for a stock to recover from such a high-volume beating, and there’s little use in holding on in hopes that it will recover.
And that’s the big lesson for today. When a chart shows a stock gapping down on huge volume, the reason for the drop is almost irrelevant. Nine times out of 10, such a drop will tie a brick to the stock’s tail for a long time.
Remember that you’re not managing your portfolio to be right; you’re just trying to make money.
Learn to sell and move on.
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I have another historical speculation for today, and it has to do with beverages.
Everyone knows that beer saved civilization. You might almost say that it created civilization, because, in addition to finally protecting humans from the scourge of waterborne microbes like cholera, dysentery and typhoid fever (not to mention the nasty protozoa and parasites that lurk in fresh water), the desire for beer was a potent stimulus for agriculture to produce the cereal grains needed for large-scale beer production.
But while beer may have been a huge gift, a form of hydration that wouldn’t make you sick or kill you, it’s also an intoxicant. Beer drinkers can be healthy, but it’s not the ideal drink if you want to be productive.
So my real topic today is a specific period when Europeans got the three big alternatives to beer as a safe beverage, coffee, tea and cocoa. I’ve used the date of arrival in London for all three as a convenient measure.
Coffee first got to Europe via Venetian traders in 1615 and the first coffeehouse in London was established in 1652 in St. Michael’s Alley, Cornhill. Within 25 years there were 3,000 coffeehouses in England
The first samples of tea reached England between 1652 and 1654, and the first tea served to the public was offered at Garway’s Coffee House in London in 1657.
While the first cocoa beans began arriving regularly in Spain in 1585, it took a while for a taste for them to develop in England. Amazingly, 1657 is also when chocolate (the beverage) arrived in London, courtesy of a Frenchman whose shop was called The Coffee Mill and Tobacco Roll.
My speculation is this: After centuries of the salutary (but not stimulating) drinking of beer and wine, what must the effect have been of the arrival of three powerful stimulants in a major market town like London within five years of one another!
Drink a lot of beer or wine and you sing, you carouse and you fall asleep on the table (or under it).
Drink a lot of coffee, tea or cocoa and your mind gets hopping with ideas, you want to stay up late and talk and write and do all the other stuff people do when their brains are in high gear. (It’s probably no accident that Lloyd’s of London began life in 1688 as a coffeehouse.)
I guess it’s no accident that the 17th century in England is known as the Age of Reason.
And I’m leaving out of this speculation the effect of a little weed brought back to England by Sir Francis Drake in 1573. Its Latin name was Nicotiana tabacum.
Stimulants are fine for thinking great thoughts, but there’s no denying the attraction of alcohol, the world’s favorite central nervous system depressant. And there’s a fairly young Chinese company (incorporated in 2000) that’s doing quite well producing and distributing corn-based alcohol in the People’s Republic.
The company is China New Borun (BORN), and most of its alcohol heads straight into baijiu (the name means “white liquor”) the Chinese equivalent of vodka, which is available in strengths from about 80 to 120 proof.
New Borun also gets revenue from the byproducts of the distillation process, including the grains left over and even the carbon dioxide that results.
The company’s quarterly results have been growing strongly, with four quarters of both revenues and earnings growth in excess of 100%. The most recent quarter featured earnings growth of 153% on 156% revenue growth, with a 15.5% after-tax profit margin.
BORN came public in the U.S. in June at 7, and after dipping from 7 at IPO to 5 in July, the stock got moving in mid-July, soaring to near 10 in August. The stock has built a short cup-with-handle base here, with its sides at 10 and its handle trading sideways for a few days. The stock is still cheap, with a forward P/E ratio of 6.
BORN has plenty of risk factors, including its youth, its low price, its relatively low trading volume (just 352,000 share a day, on average) and its lack of support from institutional investors.
But there’s plenty to like, as well, including a chance to participate in the Chinese consumer sector, which isn’t easy to do.
For Cabot Wealth Advisory
Editor’s Note: Paul Goodwin is the editor of Cabot China & Emerging Markets Report, which is ranked #1 for the last five years among financial newsletters by Hulbert. The Report is up 128% during that time (due to Paul’s expert stock picking and market timing advice), while the market is up only 1.5%! Don’t miss out on the next five years of gains—subscribe today!