23 October 2016
Investors should beware of risks that can come with cheap valuation. Photo: Bloomberg
Investors should beware of risks that can come with cheap valuation. Photo: Bloomberg

Buying cheap can sometimes prove expensive

Real Nutriceutical Group (RNG, 02010.HK) recently announced the change of auditor.

From a corporate governance perspective, there are two things investors should be cautious about: frequent resignations of non-executive directors and a sudden exit of the auditor. 

RNG’s financial year ended on Dec. 31 and the company is due to release its annual results. Investors should stay vigilant.

RNG mainly produces and sells nutraceuticals and medical products. The share price was about HK$2 a year ago. Many analysts then recommended the stock as it was felt that the firm had bright prospects and stable sales growth.

But now the stock closed at HK$0.7 on Tuesday and the price-earnings multiple is just one. Its market cap is HK$1.1 billion, even lower than its net cash of HK$1.5 billion (interim data 2015).

So, what’s wrong?

Value investing doesn’t mean you should buy whatever the price is cheap. The key is to know the value.

RNG raised HK$1 billion from an initial public offering in February 2010 and issued new shares to raise another HK$600 million in October that year. And last year, it issued new shares several times.

Why is the major shareholder willing to share big profits if the outlook is really good?

Cheap is good, but it’s better for us to stay away from things we don’t understand.

As a value investor you should put yourself in the company manager’s shoes, thinking about whether the business is sustainable and valuable to run, among other questions.

The rule is to avoid the hidden risk behind cheap valuation. If you have picked the right one, time will be on your side.

This article appeared in the Hong Kong Economic Journal on Feb. 24.

Translation by Myssie You

[Chinese version 中文版]

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Columnist at the Hong Kong Economic Journal

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