Growth and Shareholder Dilution
posted by The Traveller on Sunday, May 30, 2010

In the China Small Caps space we find very many companies that grow net income by 30% and more year-over-year, so we can safely categorize them as 'Growth Stocks' by definition. However, it isn't actually net income growth that matters for valuation, it is EPS growth -- and here the picture can look quite different if we go into detail. Shareholder dilution is a common problem amongst US-listed Chinese stocks and while I do fully understand the need to raise money to fund growth, we have to look if the significant increase of the share count does actually translate into EPS growth for shareholders.

Let's have a look at seven randomly selected names in the China space, seven stocks that cover a variety of industries. All are traded on senior US exchanges.

Net Income Growth
TickerCompanyNet 2008Net 2009GrowthNet 2010*Growth*
CAGCChina Agritech8,641,74115,584,05680.33%23,500,00050.80%
CCMEChina MediaExpress26,367,00041,711,00058.19%73,000,00075.01%
CELMChina El. Motor8,015,89211,497,69843.44%18,450,00060.47%
CNETChinaNet Online2,800,0008,444,000201.50%14,100,00066.98%
DEERDeer Consumer Prod.3,356,78412,369,062268.48%26,000,000110.20%
ONPOrient Paper8,774,41512,720,20844.97%18,000,00041.51%
YONGYongye Int'l11,191,77926,205,453134.15%43,500,00066.00%
(2010 Net Income based on the midpoint of official company guidance)

All seven stocks posted stellar numbers for 2009 with net income growth between 43% and 268%. 2010 guidance is also very positive for all seven companies. Now we should have a look at how the share count (fully diluted) has increased from January 2009 until today.

Shares Outstanding / Dilution
TickerCompanyO/S 2008O/S 2009O/S 2010*Dilution 2010Dilution*
CAGCChina Agritech12,349,80814,228,94318,909,21932.89%53.11%
CCMEChina MediaExpress20,915,00022,998,13833,499,82645.66%60.17%
CELMChina El. Motor10,679,26012,356,53021,244,74371.93%98.93%
CNETChinaNet Online13,790,80014,825,12521,059,68342.05%52.71%
DEERDeer Consumer Prod.16,985,46023,190,28633,767,21245.61%98.80%
ONPOrient Paper10,769,89612,232,87818,336,56649.90%70.26%
YONGYongye Int'l20,106,43331,324,83044,696,42742.69%122.30%
(shares outstanding 2010 based on Q1/10 10-Q filing)

Whoops! And the 2010 numbers are based on the May filings, there are still seven months to go for increasing the share count even more. Now let's look at the income numbers again, but this time we'll measure growth on Earnings per Share:

EPS Growth
TickerCompanyEPS 2008EPS 2009GrowthEPS 2010*Growth*
CAGCChina Agritech$0.70$1.1056.52%$1.2413.47%
CCMEChina MediaExpress$1.26$1.8143.86%$2.1820.15%
CELMChina El. Motor$0.75$0.9323.97%$0.87-6.67%
CNETChinaNet Online$0.20$0.57180.53%$0.6717.55%
DEERDeer Consumer Prod.$0.20$0.53169.68%$0.7744.36%
ONPOrient Paper$0.81$1.0427.63%$0.98-5.60%
YONGYongye Int'l$0.56$0.8450.29%$0.9716.34%
(2010 Net Income based on the midpoint of official company guidance)

Already looks a little less exciting, doesn't it? Here are the 2010 numbers next to another in one table:

2010 Growth
TickerCompanySharesNet IncomeEPS
CAGCChina Agritech32.89%50.80%13.47%
CCMEChina MediaExpress45.66%75.01%20.15%
CELMChina El. Motor71.93%60.47%-6.67%
CNETChinaNet Online42.05%66.98%17.55%
DEERDeer Consumer Prod.45.61%110.20%44.36%
ONPOrient Paper49.90%41.51%-5.60%
YONGYongye Int'l42.69%66.00%16.34%

Based on official company guidance and current share count as of May 2010 (assumed there will be no further dilution this year), all seven companies will grow net income by more than 40% but only one of them will be able to grow EPS by more than 40%. Two of the selected companies will likely end the year with negative EPS growth, while the remaining four should post rather unimpressive EPS growth between 13% and 20% for 2010.

For your investment decisions you should always look at projected EPS growth as well. Most companies will not give EPS guidance - instead they project high net income growth only and leave it to the investor to bring those numbers back down to earth. You should always think about possible shareholder dilution when a company doesn't provide EPS guidance, especially in the China Small Caps space.

This post doesn't mean the named companies would not be undervalued here, in fact most of them trade at very low multiples, and with market sentiment for Chinese stocks having lots of room to improve it is more likely that all seven stocks will trade significantly higher later this year, despite all the dilution. But if you need a reason for why the stock prices seem so depressed in selected emerging market names, always look into EPS growth first

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At May 30, 2010 9:00 pm , Blogger Dutch Trader said...

Good post, why you don't post in on

If you don't want to post there, I can post it with your permission.

At May 30, 2010 11:13 pm , Blogger The Traveller said...

Thanks! I do actually have a seekingalpha account but couldn't be bothered yet to cross post as I will move this site to its own domain next month.

At June 01, 2010 4:48 am , Anonymous Anonymous said...

Looks to me like CCME should command the highest P/E of all the stocks, as its numbers are far bigger than the other stocks mentioned. I can count on one hand how many companies grew net income from $26 million to $41 million in one year. Nice article.

At June 01, 2010 12:30 pm , Anonymous Anonymous said...

yes, eps growth is half of the equation, PE expansion is the other half. CCME may see its PE double in a year and it's still cheap relative to its peers. The other thing is the eps growth described here is based on most recent guidance which itself is based on rather conservative assumptions and mostly organic growth and leaves out the effect of real growth by acquisitions or by rapid addition of revenue sources like busses for CCME, branded outlets for YONG... In the latter case, the 66% earning growth guidance is based on growing the # of branded stores from 9000+ by EOY 2009 to 20000 by EOY 2010, an average addition of 30 outlets per day. The actual growth seems to be much faster thus far with almost 4800 outlets added in Q1/10 or 50+ outlets/day. At this pace the # of producing outlets could almost triple yoy by end of the year and earning could double. Also, M&A could be another factor. Just pointing a few other things that may ultimately affect price appreciation.

All in all, the article is a very interesting objective analysis.

At September 18, 2010 1:55 pm , Anonymous Anonymous said...

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