Separating Winners From Losers in China

One valuable lesson I learned on Wall Street is that the decision to hold a stock is identical to the decision to buy a stock. Either way, when you wake up the next morning you are long that position.

If a stock is really considered a hold or a neutral, then clearly it should be a sell. If the stock isn't expected to appreciate (or if it's not a clear buy stock), then why allocate funds to it? Investors are better served selling this type of stock, doing their homework and finding a stock that will appreciate. Holding a stock that has no identifiable upside is inherently dangerous because all stocks have downside risk, which is presumably only tolerated because of its upside potential.

Another lesson I learned is that although stock prices are unpredictable, stock fundamentals and company performance are often very predictable. Companies that have consistently generated strong profits in the past tend to keep doing so, while companies that have consistently lost money tend to keep doing so.

Late last year I wrote an article comparing an unlikely pair of stocks, A123 Systems (AONE) and Orient Paper (ONP), which illustrates this concept very well.

A123 Systems, which is in the hot space of lithium ion battery technology, has lost money every quarter it has existed and in fact has negative gross margins. On a firmwide basis, it doesn't even make money on each individual sale.

Meanwhile, Orient Paper is in the boring space of paper production and has gross margins of around 30% on a firm wide basis. But on individual sales they can effectively get 50% margins. In other words, for every ton of paper they sell, they double their money.

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