November rain

It's been a nasty November so far. Seems like my "bears have accomplished diddly squat" comment a couple weeks ago motivated Mr. Market to dish me out some humble pie! With this week's decline, the medium term trend is clearly down and so assuming this is just a correction, we need to look for some signs of extremes which in the past have marked the end of such corrections. Specifically, I'm looking for 2:1 bears vs bulls in AAII, NAIIM to show a net long reading of sub 40 and a sizable weekly outflow in equity mutual funds. Despite the market showing weakness over the past few weeks there has been a reluctance of the above indicators to reach the extremes I'm looking for...they have been stubbornly too bullish but I think after this weeks damage, we will see this change very soon. Anyone who bought stocks on the basis of things like "favorable Nov-May seasonality",  "no more election uncertainty" and other flimsy reasons are weak longs and such weak longs have probably been shaken out this week adding to the selling pressure as they capitulate. Other weak longs were those under-invested managers I talked about in September who panic bought stocks on the announcement of QEX. These guys are now underwater sucking wind and likely puking stocks because they panic bought while never really truly believing in the bull market to begin with.

This brings me to my next point...conviction. I believe that when you take a position you need to have a certain degree of conviction so that you can be a strong holder and not get shaken out by ST volatility. I've seen instances where those who are LT bears try to go "long for a trade" and they usually lose on such trades because they are inherent bears and have little conviction in their long trades and so they get easily shaken out if they get caught during one of these corrections.  In order to have conviction you need to truly believe in your trade and to do that you need to have "substance" behind your trade...you have to have solid reasons to believe in it. I will never take a  position because of seasonality, elliot waves, fibonacci retracements and the like because this is the equivalent of building your house on air...there's no substance. It's all useless bullshit. If you want to see what I mean by substance, read on.

In my previous post I asked what you would pay for the company I had described but nobody answered. Fine be like that. I asked the same question on facebook and only 1 person responded (a business owner). He said he would pay $50 Million. The business has $13 M in net cash. Let's assume $3 M is required for working capital; that means if he buys the business for $50 M he gets to pocket $10 M in cash making the effective purchase price only $40 M. Based upon annual earnings of $9.5 M, that gives you an annual return of about 24% on your money and in just over 4 years, you'll recoup your investment cost (p/e of 4). That's pretty sweet isn't it? Especially if the business has proven to be very steady over the years.

This business I just described is not being valued at $50 Million, which as I proved, would be more than a fair price for a prospective buyer. The business is actually being valued at only $15.5 Million! This company I'm talking has its stock trading in Canada but it's business is located in China and so perhaps there deserves to be some discount for a foreign buyer due to political risks but a $15.5 Million valuation for a company poised to earn at least $9.5 M this year, represents a discount that's beyond asinine considering the company's pristine balance sheet and stability/predictability of future earnings. When I buy a stock that's so grossly undervalued like this I'm a strong holder and I don't care what the market does. My convictions have "substance" behind them and a result, I'm not going to get shaken out if the stock dips from when I bought it because in time, unless the company is a scam,  it's practically guaranteed that the stock will go up substantially due to the earnings it's generating vs its valuation and since the company has no net debt, it can't go bust. Why is the company valued so low? It's probably because the company is a Chinese RTO and there have been cases where such companies have turned out to be frauds. Sino Forrest is the biggest of such cases. Nobody wants to touch these stocks because of these scams but I see that as an opportunity as I'm sure not every Chinese RTO is a scam. Based upon my DD, this company I've been talking about appears legit.

The way I look at it is this. If the company is legit it's pretty much guaranteed the stock price will at least double within a year. Of course if it's a scam it goes to zero and as I said, the company appears to be kosher so the risk/reward is well worth taking a LT position. I'm going to meet one of directors of the company next week and so hopefully that will increase my knowledge and confidence in the company.