Stocks with shaky fundamentals and high multiples get hit the hardest in a market downturn and should be avoided when markets look stressed. Examples include solar stocks such as Suntech Power ( STP), Trina Solar ( TSL), Yingli Green Energy ( YGE), LDK Solar ( LDK), Canadian Solar ( CSIQ) and Solarfun ( SOLF). But a market selloff can be a good opportunity to pick up cheap shares of oversold stocks with rock-solid fundamentals. The best example is Duoyuan Printing ( DYP). As the markets were melting down last week, I ran a few stock screens to see which China stocks were getting hit the hardest and also to see if I could find anything with strong fundamentals that looked oversold. By far, the worst performing China names from last week were the solar stocks, all of which were down by more than 20% for the week. The solar stocks all share some commonalities: They have a short or mixed profitability record and they have been trading on very high multiples. However, the selloff also has dragged down other stocks such as Duoyuan Printing, which now trades at 6.5 times earnings despite 25% to 30% net margins, strong growth and a solid balance sheet. I was buying while others were selling.
Looking at the solar stocks, Yingli has been on-again, off-again with profitability and has nearly $700 million of short-term debt. Solarfun has just begun to eke out a profit recently but with a razor thin net margin. Suntech Power fares much better on the fundamentals side, but was trading at a price-to-earnings ratio north of 30 just a week ago, despite single-digit net margins. Now it trades on a P/E of 20 and could certainly go lower. The fear with all of these stocks is that cash-strapped governments will be hesitant to continue subsidizing solar energy with government money and that solar profits will take a hit. From a valuation standpoint, they could have a long way to fall. As solar was busy imploding, I was busy looking for stocks that might be oversold, getting dragged down with the market. Duoyuan Printing was the best name I found and I was picking up shares whenever the market looked its ugliest. I owned the stock earlier this year and have been watching it closely waiting for the right time to buy in. As recently as April, it was trading near $11, but now is selling for less than $8. If it trades down more I will certainly buy more.
The reasons I was buying while everyone else was selling are based on a combination of fundamentals, growth and valuation. The company is a New York Stock Exchange-listed manufacturer of offset printing equipment in China and has a current market cap of $240 million. Despite tremendous profitability and a NYSE listing, this company has traded down to levels where it's at a P/E of only 6.5 times trailing earnings. Looking back at past quarters, DYP has consistently maintained huge gross margins of around 50% and net margins of 25% to 30%. The company has maintained solid annual growth of more than 20% and Tuesday will release results for the March quarter, which are expected to exceed last year's March quarter by roughly 20%. (Note: March is DYP's slow quarter, so revenue vs. the strong December quarter will naturally show a decline). On the balance sheet, as of December, the company had $97 million in cash and minimal debt. Other cash equivalents include over $44 million in short-term receivables. On a per-share basis, the company consists of $4.62 in cash and equivalents vs. the current share price of $7.84. The company has also been a cash machine, generating over $24 million of cash in the six months ended December. Duoyuan Printing is run by Chairman Wenhua Guo, who also happens to be the chairman of Duoyuan Global Water ( DGW). Looking at the two side-by-side shows an interesting contrast. Both companies release earnings this week, so these are trailing 12-month numbers.
Despite very similar fundamentals and management, DGW trades at more than four times the multiple of DYP. Part of this is due to the fact that DGW is in a "clean tech" water treatment business and gets the usual clean tech multiple bump. The other part is that DYP is just plain trading at the wrong price, well below its fair value. With the state of the markets now, I'm not even trying to set my own share price targets. But noting that DYP already trades at only 6.5 times trailing earnings, I feel that it doesn't have much further to fall. And if it does I will be jumping in to buy more. On the upside, even if DYP was trading at a low multiple of 10 times earnings (at a price of around $12) that is a 50% jump from current levels and would still place it on a P/E of about one-third that of DGW. With this combination of growth, profitability and balance sheet strength I feel that a reasonable multiple should be in the teens, which would be a double from current levels.
Obviously, a stock is only worth what someone is willing to pay for it. However, DYP is a stock I am not losing any sleep over and I think right now is a good opportunity to pick up shares at a very low multiple.