Today, I will show you how I made 153% gains (both capital and dividends) on a severely undervalued watch company listed on the Hong Kong Exchange.
First, the evidence.
These are real case studies made on our past transactions – we believe in having ‘Skin in the Game’ and share only what we do rather than just having theory and storytelling.
I will explain the rationale behind my decisions as well:
- Why I Bought: Severely undervalued with positive operating cash flow.
- Why I Held: Fundamentals of the business did not deteriorate.
- Why I Sold: Rules that I follow due to my own investment framework
More then anything, the above 3 actions of buying, holding and selling are the only actions investors can take – thus, it is crucial to know as an investor when you must undertake the 3 actions BEFORE you even buy the stock.
We must operate similarly to fighter plane pilots in this scenario. Where they decide to eject not while in the fighter jet, but years and years ago in their training – “Perform X actions, if Y happens.”
As investors, we must have a similar framework and a rule to follow: We go in only when we know what our target prices are, why we bought, and why/when we would sell.
A Quick Story
A Rolex watch can easily cost S$10,000. A Patek Philippe at S$100,000 isn’t a surprise.
What if I told you, that you could have both for just 20% of their original price?
I happened to chance upon a company selling such luxury watches at 20% of their value. It was so ridiculously cheap that it scared off investors.
It was 2016 and Oriental Watch popped out in my stock-screening for undervalued stocks in Hong Kong.
We have similar companies like Hour Glass and Cortina listed in the SGX but they were nowhere near as cheap as Oriental Watch.
Why was Oriental Watch so Special?
It’s because most of their customers were Mainland Chinese.
The rapid and massive rise in wealth of the Chinese led them to develop a taste for the finer things in life. Boutique stores that peddled luxury goods like Oriental Watch enjoyed the patronage of this swell of new customers as a result.
Life was good until President Xi Jinping wanted to rein in on corruption in China.
The Government arrested numerous people, including high profile officials like Zhou Yongkang.
This discouraged ostentatious displays of wealth in public. I suppose buying luxury watches is one of those acts that may get yourself into trouble.
To the mainland Chinese, the message was well-received: best to err on the safe side and not risk your head for a pretty watch on your wrist.
Oriental Watch’s business was slowed by the corruption campaign in China. The lack of spending drove the revenue and profits lower. It wasn’t a surprise the share price went down with them.
The stock appeared as a flashing buy at that point in time. Let me run you through my calculations and explain to you why.
Why I Bought
There was a whopping HK$1.5 billion worth of luxury watches (see inventories in the image above). The total liabilities was less than the cash they had in the bank!
So we now know two things: they could pay off liabilities with cash on hand. And their goods on hand was basically a bonus on top of everything else!
The crucial question that remained was:
what were the value of the unsold watches on hand?
My hypothesis was that it wouldn’t be that bad because luxury watches retain value pretty well as long as they are not worn and still in good condition.
Knowing that, I went ahead to discount the current inventory of watches at 50%. I wanted a large margin of safety when calculating the valuation of Oriental Watch.
The cash of $403,804,000 would be able to net off the total liabilities of $376,010,000. Half of the inventories would worth $784,764,000.
Such values are too large so we can just divide by the number of shares of 570,610 to get per share value.
If Oriental Watch halved the values of their luxury watches, the company should still worth HK$1.38. But the share price was HK$0.93!
Why I Held
They made a loss in 2016 but their operating cash flow was still positive. So their business would continue as long as they were able to generate the cash. They would be able to breathe while in losses and hang on till the business turnaround.
The sales improved slightly by 3.6% in 2017 and Oriental Watch swung to profit. The management became more confident and even gave out a special dividend that year!
Of course the share price follow suit and gained 100% within a year as more investors realised the stock price was unjustified.
However it was not time to sell yet as the stock was still undervalued so I held on. It had not yet met my target price expectations.
2018 sales was down 8% compared to 2017 but the net profit rose nearly 10 times! This was due to lower cost of sales, which I suspect was a result of the depreciation of their watches when they couldn’t sell them in the previous years.
The management again gave out a special dividend. This time it was even 5 times more.
The share price shot up higher as a result.
Why I Sold
I have two exit rules:
- The first rule is to exit when it has reached my target price point.
- The second rule is to exit a value stock after 3 years.
The decision is made based on data from academic studies and back-tested information, but the short and sweet statement is that we want to avoid getting stuck in a value trap. You can read more about the value trap and why we chose the
I had to sell it in Feb 2019 and I did so at HK$2.05. It was a 153% gain including both capital and dividend gains.
- I didn’t have super insight. All I did was to follow an investment process to identify the opportunities for me.
- I didn’t have a crystal ball to know the stock would move up. I trusted the process and the common sense that it was really very undervalued based on the assets that they had.
- I didn’t require extensive research or build complicated models to value the stock. It was simple mathematics that you and I learned in primary school.
- I didn’t have
highIQ – I just had common sense.
- I do have the courage to be a logical contrarian, to buy a stock based on well-grounded reasons while others are dismissing it.
- I admit that there may be some elements of luck but have I not had a proper investment strategy, I would not have been able to profit from it. The better your investment strategy is, the more ‘luck’ you have!
The strategy I used to identify this stock is a part of my overall strategy called Factor-Based Investing. You can join my intro-course over here for free. Limited seats available.
Co-Founder. Believer of the Factor-based Investing approach. Running a Multi-Factor Portfolio that taps on the Value, Size, Profitability and Momentum Factors. Quant at heart. Believe the financial industry can treat their customers better. Wants to change the world.