I came across a company listed in Hong Kong back in 2014. The company has a strong balance sheet, a fast growing business, low valuation and a high insider shareholders’ ownership. The company ticked all the criteria for me when looking for a bargain in the market. Yet, there are some issues with the company that make me less than comfortable investing in them. So, when faced with such a company, what is the best course of action for an investor? This is what I was to discuss today.
The company in question is Wonderful Sky Financial Group Holdings (HKG:1260). It is a public relationship and investor relationship firm based in Hong Kong. Basically, the company managed the IPO roadshow for companies that are planning to list on the Hong Kong or Chinese Stock Exchanges and also help with the investor relationship management after those companies are listed. The company has been growing rapidly since 2010. Its revenue and profit increased from HK$166.3 million and HK$57.3 million respectively in FY2010 to HK$458.5 million and HK$153.8 million respectively in FY2014. That is a growth rate of about 28% for both its revenue and profit for the past 4 years. With the restarting of the IPO pipeline in China, the growth only seems to be accelerating. Yet, at the time when I am reviewing the company, it is trading at less than 8 times its price to earnings if we adjusted it for its net cash position. The company is also in an extremely strong financial position with net cash position throughout the last few years. Its main shareholders also continue to hold about a 75% stake in the company.
All in all, the company almost seem like the perfect investment. Too perfect you might add, and that is what I worried about as well. The company IPOed back in 2012 but was never in need of the cash due to its strong cash flow generative business. It also planned, according to its prospectus to invest up to 3 other investor relationship firms after its IPO but that never materialised. Thus, the company is sitting on huge amount of cash that it has no use of and has no plan to distribute it to its shareholders. Then the company went and invest that cash into high-yield bonds which does not make any sense for a minority shareholder.
When faced with such a situation, what might be the best course of action for an investor? To me, there are basically 3 options.
- Do not invest in the company and forgo all possible upside from the growing business and undervalued stock.
- Invest in the company and risk the possible of complete loss if the management turns out to be dishonest or mismanaged the cash.
- Invest in a smaller allocation so as to take advantage of the possible upside but limit the downside risk for your portfolio.
Therefore, I ended up with the third option and sized my investment in this company much smaller than I would for an individual investment. Till date, the investment is close to a 200% gain in my portfolio but I am still at this moment unsure of the company. However, by sizing it at a very small position in your portfolio, I was able to enjoy the upside in the investment but still able to not be too badly impacted if my investment thesis turn out to be wrong for this company.
I do hope my little story on how I decide on my allocation decision might help you in your investment journey. Good luck.
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The information provided is for general information purposes only and is not intended to be any investment or financial advice. All views and opinions articulated in the article were expressed in Stanley Lim’s personal capacity and do not in any way represent those of his employer and other related entities. Stanley Lim owns Wonderful Sky Financial Group Holdings.