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
|Ticker||Company||Net 2008||Net 2009||Growth||Net 2010*||Growth*|
|CELM||China El. Motor||8,015,892||11,497,698||43.44%||18,450,000||60.47%|
|DEER||Deer Consumer Prod.||3,356,784||12,369,062||268.48%||26,000,000||110.20%|
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
|Ticker||Company||O/S 2008||O/S 2009||O/S 2010*||Dilution 2010||Dilution*|
|CELM||China El. Motor||10,679,260||12,356,530||21,244,743||71.93%||98.93%|
|DEER||Deer Consumer Prod.||16,985,460||23,190,286||33,767,212||45.61%||98.80%|
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:
|Ticker||Company||EPS 2008||EPS 2009||Growth||EPS 2010*||Growth*|
|CELM||China El. Motor||$0.75||$0.93||23.97%||$0.87||-6.67%|
|DEER||Deer Consumer Prod.||$0.20||$0.53||169.68%||$0.77||44.36%|
Already looks a little less exciting, doesn't it? Here are the 2010 numbers next to another in one table:
|CELM||China El. Motor||71.93%||60.47%||-6.67%|
|DEER||Deer Consumer Prod.||45.61%||110.20%||44.36%|
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