Choosing a Trade

In his book Basic Economics, Thomas Sowell says that economics is the study of the allocation of scarce resources that have alternative uses.

This is the true of our stock trades. Every stock trade uses money, and that money has alternative uses. You could have spent it on a chest freezer, which would have earned you money every month by allowing you to buy meats in bulk when they are discounted. Which one is more beneficial? We all get $$ in our eyes, and assume that the stock market is preferable. Anyway, that’s the thing to think about.

The reason people make bad decisions with the stock market, is that they think that price is everything. If price is your only concern, you are not an investor. At best, you are a speculator, but probably a bad one. When you choose stocks, you need to image what would happen if the price of a stock went to zero or was de-listed. If so, assuming nothing changed about the company, was it still a good buy? Note I didn’t ask if you could get a better buy – if you only look for the best buy ever you will be disappointed. The question is whether or not it was a good buy. If the answer is “no”, then you shouldn’t buy the stock, period.

Now, a lot of people who only hear about the stock market in the news may wonder how this can be true. Isn’t the whole reason to own stock in order for the price to go up?

No, it isn’t.

The purpose of owning stock is to own shares of a company that produces value to its shareholders over a long period of time. This is true even if the company’s shares are never traded. Imagine that you were the owner of a private company. Ownership still yields value even though there is no price or market for trading your company. Instead, you get benefits through (a) increased value of assets, and (b) dividends/profits. (a) only really matters if the company goes out of business. (b) is really what you are looking at.

If you purchased a stock at $10 and the stock is de-listed (i.e., you can’t trade it – the price is effectively zero) but the company generates $1/year in dividends every year, you would have still made a winning trade. If the company goes out of business, and its assets are liquidated for the price of $20/share, you would have doubled your money.

None of these are typical situations, but the point is that focusing on purchase price alone will get you in trouble.

The way that I trade is that I look for companies where, at the current price, I would rather have the stock than the money. This way, even if the company’s price goes down, it doesn’t bother me, because I would want the stock more than the money even more. If I wouldn’t still like the stock if it were lower-priced, I don’t buy the stock. If the entire stock market is overpriced, this means I don’t join in – which is a PERFECTLY FINE way to be, and don’t let anyone tell you otherwise.

Now, the circumstances of the company can change, or you may not have known something that other people know, or that nobody knows. And this knowledge can change how you feel about the company. That’s okay. That happens. That’s learning, and buying bad stocks because you didn’t know all the things is the price of learning.

Anyway, all of that to introduce my main current trade, Future FinTech Group, currently trading at $2.70. I don’t have the time to tell you everything I like about them, but let me give you a few things:

  • The price-to-book ratio is 0.15. That means that buying a share for $2.70 literally gives me $18.00 in assets. That’s a great price! Now, not every price-to-book ratio is good. Sometimes a company has “assets” that they couldn’t possibly sell, or they are losing money so as to eventually wipe out the book value of their company. But in this case, these seem to be factories and land. So buying $18 worth of factory and land for $2.70 is a great price, if the business is viable.
  • The company has a gross profit. The gross margin is not great, but it is workable – 23%. Kellogs, for instance, has a 43% gross margin. This could definitely improve, but what it means is that the company is stable enough to probably not bleed out its book value.
  • They have an EBITDA profit – they actually pulled in a 10% profit. However, once taxes, depreciation, and amortization are factored in, they were not profitable. They did post a loss, but MOST of that loss is in depreciation and amortization. Apparently, they had a write-down from a previous acquisition. If I understand the numbers correctly, they actually posted a 3% NET PROFIT. That means that the value of the company is going UP

Additionally, it looks like they are expanding markets. The company used to be called SkyPeople Fruit Juice (I actually wish they kept that name – it’s fun!) but renamed themselves to Future FinTech Group to reflect their growing markets. They are getting involved in the commodities markets in china, so wanted to have a more serious sounding name than just the name of their public brand.

So, we have profitable, expanding company, which for $2.70 you get to buy $18.00 worth of assets, plus a share in future profitability. I’m in. Additionally, I heard rumors that this was one of the few chinese firms that didn’t have to restate earnings after being audited by NASDAQ. If true, that also means that they are very reputable.

Because it is a chinese micro-cap stock, the stock itself has been quite erratic. But, even if it goes down to $1 I’m still holding on, because this seems like a great company. I’ll start thinking about selling out at $10, and probably do it at $20-$25. At that point, the value of the money will be near the value of the company itself, and it will be time to look for another bargain. And, if it never goes that high, the value of it seems like it is more valuable than the dollars I can trade for it.

Additional Note

I should note that when you choose the price that you are willing to buy at, you are in a much stronger position. You choose your price. If later it goes on sale for a better price, that doesn’t really impact you if you chose the stock for the intrinsic value. I set the price that I buy and sell at, not the market. If the market doesn’t play along, there is not reason I have to play.

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