Cabot’s “Stock of the Month” … hint: it’s Chinese

Timothy Lutts doesn’t often send out really over-the-top out teaser ads, so I don’t often write about the various newsletters from Cabot — I do hear about them from time to time, and readers have reviewed a few of the services, but they haven’t yet bombarded us with “super hype” as so many other publishers do.

So I’ve got to find my clues and my teasers where I can — and in a recent email there were some hints about the latest pick for the Cabot Stock of the Month Report, which chooses one of the stocks picked by the other Cabot newsletters to highlight each month (they choose the best stock from that group, they’ll tell you — though of course, time will tell).

And the pick this month is from what had been an extremely high performing newsletter — the Cabot China & Emerging Markets Report. Of course, part of the reason it did so well was that China did so well, but it was atop the Hulbert leaderboard for much of 2006 and 2007, and according to the publisher it didn’t do nearly as badly last year as some other emerging markets letters — so perhaps it’s worth a look?

Unfortunately, the clues for their pick of the month are a little bit thin … here’s what we get:

“I’m very excited about this month’s stock for several reasons. One, it’s a great growth company, with revenues up 79% in the latest quarter and earnings per share up 52%. Two, it’s located in China, where there is no recession and where GDP is expected to grow about 8% this year. Three, it’s not well known, mainly because it only came public in late 2007. Four, and most important, our Cabot China & Emerging Markets Report just gave a buy signal!”

I think 8% growth might still be a bit optimistic for China this year, but certainly they’re still going to grow — and unlike the US, they have the cash to pay for their big stimulus programs, and the convenient discipline of a totalitarian regime that prevents the messiness of democratic stimulus and recovery debate, so the odds do seem to favor the Chinese economy being an above average grower going forward.

But what is the company they’re picking?

Well, I can’t be 100% certain with those limited clues — especially because this isn’t a perfect match for those clues, but I’ll give you my best Gumshoe guess:

Longtop Financial Technologies Limited (LFT)

This is one of relatively few IPOs from the fourth quarter of 2007 — which is when the market most recently peaked — that’s actually now well above the IPO offering price, which was $17.50 for LFT … as I type, the shares are going for about $23.50 (still far below the high price it actually traded at on that first day of better than $30, it was only the subscribers to the IPO who got that nice $17.50 price).

And yes, it is a growth company — which is why this is the best match I know for the clues given. They did have revenues that grew by 79% in the most recent quarter, as teased, but the earnings growth wasn’t necessarily exactly 52%. Earnings numbers always have a bit more play in them than revenues, but they reported earnings growth of 57.7%, and earnings per share growth of 45.6% … so perhaps you can split the difference if you like and fudge it to 52%, but just note that we might not be dealing with an exact match here.

This is a software company, focused on the financial sector (software solutions for banks, brokerages, etc.) — and while some other companies that rely on banking customers are hurting, they don’t appear to be right now. Software is generally a nice, high-margin business (LFT certainly exemplifies that, with gross margins of better than 70%), and financial services in China appear likely to be a boom market for quite some time as personal banking services grow to match the offerings of the more developed world.

There was a nice article on them in Investors Business Daily ten days ago, which also serves to reinforce the fact that this is a growth stock … and, to some extent, a momentum growth stock. They’ve also beaten earnings estimates four quarters in a row, which helps them to get an “A” from Louis Navellier’s grading system … which will probably entice some of you, and repel others.

Some growth stocks are also “value priced” these days, trading at levels that assume their growth will tail off, or that they’ve got hidden trash in their closets — not so for Longtop Financial, they trade at a substantial premium to the market. The current PE is in the mid-30s, and the forward estimate would give them a PE of about 21 — though earnings growth for the just-begun year (their fiscal year ended on March 31) is estimated at about 15%, pretty nice for a year when many companies expect to see their earnings shrink.

For other research on these guys, a good starting point would be the third quarter conference call from mid-February, transcript available here. From a quick glance at some analyst reports it appears that the major concerns might be competition, with more global software companies pushing into China and other local companies trying to grow; and concentration, with a huge amount of their business coming from the big four Chinese state-controlled banks, though they have also made a big push into insurance companies lately. Morningstar thinks they’re trading about 25% above fair value right now, for whatever that’s worth, and they get a very strong trend score from MarketClub.

If you’d like to make a different guess about the solution to these clues, here’s a good list of the fourth quarter IPOs from 2007 — it includes quite a few Chinese companies, none of which is nearly as close a match as Longtop Financial as far as I can tell … but who knows, maybe I missed something, or maybe their “late 2007” clue was a bit squishier than I assumed.

Chinese stocks have certainly been on a nice trend in recent months — beating many other sectors and countries, on average — but there are plenty of folks who are still terrified of the repercussions of the economic shock for the export-dominated economy. Do you think we’ll see sunny days ahead for Longtop, or do you have a favorite Chinese investment to share … or do you think we should run away from the Middle Kingdom? Let us know with a comment below.

And if you’ve ever subscribed to any of the Cabot newsletters, please share your opinion by clicking here — we have one review in place for the Cabot China & Emerging Markets Report and a few for Lutts’ Cabot Market Letter, but none yet for the Stock of the Month Report.