In other words, a stock picker is unable to outperform the overall market through savvy stock selection or market timing, and the only way to obtain higher returns is to take on greater risk. Needless to say, this theory is widely disputed and by this market participant, in particular. That’s because time and time again I have been able to uncover undervalued and under researched small caps shares that have gone on to generate substantial amounts of ‘alpha’ - the excess return above the market’s overall return - without taking on high levels of risk to do so. Indeed, if EMH held true then my first quarter housebuilder effect, which I first uncovered over a decade ago, simply would not work since it is now a widely known fact that the sector outperforms the market in the first quarter. If anything it is a lower risk trade to hold the housebuilders than the market during this period. In fact, shares in the homebuilders have beaten the market in the first quarter each year for almost 90 per cent of the time during the past 34 years, and continue to do so.
Equally, EMH dictates that the outperformance of my annual bargain share portfolios over the past 15 years is down to the higher risk of the constituent companies in these portfolios rather than savvy stock picking of undervalued small cap shares. I would dispute this as for the large part the risk profile of the companies I select is no higher than the average small cap share. However, some clearly do carry more risk and in the past week one of the constituents of my 2014 Bargain share portfolio, Aim-traded Camkids (CAMK: 60p), a Chinese designer, manufacturer and distributor of outdoor apparel and accessories for children, has slumped sharply even though the company issued an upbeat trading statement a month ago ahead of the release of results in mid-April.
Having returned from holiday today, what first caught my eye was the trading activity in the shares on Monday 31 March. At the start of trading the price was 83.5p, inline with the price I recommended buying the shares at in early February, but by late afternoon 250,000 of the 47.4m shares in issue had traded and the bid-offer spread had slumped to 68p to 70p. True, a fall through the 12-month low of 80p would have triggered stop losses for some investors holding the shares and this snowball effect can explain part of the decline. In turn, some investors would have been unnerved and dumped the shares in the following days. A lack of confidence in Chinese companies is not helping matters either, something I am sure bear raiders have cottoned onto by short selling the shares last week.
In my opinion, we need some perspective here. At the current level Camkids shares are woefully undervalued on fundamentals and from a technical perspective are massively oversold too. The 14-day RSI is on the floor and is giving a reading well below 20! The share price is also 40 per cent below its 200-day moving average. Moreover, if short sellers have moved in, as I am sure has been the case, then any good news flow later this month will undoubtedly see short covering as they scramble to close their short positions. With the company’s full-year results due out in mid-April, we don’t have long to wait for what should be a decent set of results to prompt that.
Chronically undervalued on fundamentals
Indeed, we already know that the company’s revenues and post-tax profits both increased by more than 14 per cent in the 12 months to end December 2013. For good measure, the order book was ahead 7 per cent in the first two months of the current financial year. We also know that Camkids has not been impacted by rivals discounting due to the resilience of its end markets in children clothing and the less crowded outdoor sportswear such as hiking, climbing and skiing. This business focus differentiates Camkids from general sportswear companies which tend to target markets for running, basketball, soccer and tennis. These specific end markets have endured a torrid time due to intense competition and overproduction.
It is this misunderstanding of Camkids business which explains why the shares are so lowly rated. In fact, assuming EPS rises from 26.3p to 30.8p last year as analyst Matt Butlin at brokerage Allenby Capital forecasts, then the historic PE ratio is only two! And it’s not as if the company has any financial worries to justify such a ludicrous rating. For instance, on the back of a bumper cashflow performance the company’s net funds had swollen to £31m at the end of December, or an eye-catching two thirds of its current market capitalisation of £47m. Strip out a cash pile of around 40p a share from the current share price of 60p, and the shares are trading on a cash adjusted historic PE ratio of 0.7! Furthermore, it’s not as if earnings growth is expected to grind to a halt as Allenby expects a modest rise in EPS to 32.1p in the current financial year.
The investment case is also underpinned by significant dividend support. Having declared a 2.3p a share payout at the interim stage in September, analysts are pencilling in the declaration of a 3p a share final dividend at this month’s results, rising to a total payout of 5.9p in the current financial year to end December 2014. On this basis, the prospective dividend yield is 9.3 per cent, rising to around 10 per cent in 2014! There is substantial asset backing too as Camkids equity is being valued 20 per cent below its last reported book value at the end of June.
Clearly some discount needs to be factored into the valuation because Camkids is a small cap Chinese company, a segment of the market investors perceive carries more risk and something I was well aware of when I recommended buying the shares in the first place in February, but a forward dividend yield of 10 per cent and a cash adjusted PE ratio below one are extreme valuations in anyone’s book. It’s also fair to say that this miserly rating is unsustainable: either Camkids will in the very near future deliver results inline with analysts’ estimates, and report a decent trading update to confound the sceptics, or it will warn on current year profits to justify the share price falls we witnessed last week. However, I just can’t see that happening as the company issued an upbeat trading update little over six weeks ago and there is no indication that trading has deteriorated since then.
If anything the read across from other Chinese retailers has been positive. For example, the board of Hong Kong listed 361 Degrees, a mass market, Fujian province, sportswear brand targeting the 18-30 age group, reported that the worst in the industry has passed. 361 Degrees’ underlying sales actually rose in the final quarter of last year after several successive quarters of declines and has been expanding the number of children outlets even though it has been cutting back on its total number of stores. This adds credibility to Camkids strategy of targeting the kids market.
So although Camkids share price decline will have unnerved some investors, I am not changing my positive stance at all. The chronic undervaluation is extreme on any measure and priced on a bid-offer spread of 58p to 60p the massively oversold shares rate a value buy in my book ahead of the forthcoming financial results. They are likely to make good reading, not to mention cause a fair degree of discomfort for any short seller.
Please note that I am working my way through a long list of companies on my watch list which have reported results or made announcements recently. These include:IQE (IQE), Pure Wafer (PUR), LMS Capital (LMS), Communisis (CMS), Eros (EROS), Inland (INL), Safestyle (SFE), Sutton Harbour (SUH), First Property (FPO), API (API), SeaEnergy (SEA), Bezant Resources (BZT) and Global Energy Development (GED).
