Monday, June 14, 2010

Jade Art

Jade is a stone used for a variety of ornamental purposes, especially in Asia. Demand for jade extends from the construction industry to the jewelry industry. Jade Art Group (JADA) is a distributor of jade with a market cap of $30 million, and an annual profit of $13 million.

Despite the seeming "commodity-ness" of this industry, Jada may actually have some competitive advantages. They acquired access to a jade mine for 50 years in return for selling its wood-carving business (which is no longer part of the company). As such, the company appears to be able to acquire jade on favourable terms (e.g. Jada is allowed to set the extraction rate, prices cannot rise by more than 10% from contract to contract, etc.).

But this investment is not without risk. Being reliant on one source of supply increases risk, as natural disasters or other unexpected incidents could result in supply disruptions. Furthermore, the company is also reliant on only a few customers, and even in Jada's short history, some of these have already defaulted on previous agreements, causing losses.

Jada's short history brings up another point. Usually, value investors prefer businesses that have been around a while. This helps investors evaluate the company over a period where many of the company's risks could come to light. Unfortunately, in this case the company has only been in this business for two years. Whether management is doing an adequate job at protecting and/or growing shareholder wealth is an open question for now.

Value investors like stocks with strong upside potential and low downside risk. While the upside potential is high here due to the low price to earnings at which this stock trades, the downside risks are also high due to the concentration of suppliers and customers and the lack of operating track record. This stock idea has potential, but investors should tread carefully and understand the risks.

Disclosure: None

8 comments:

Paul said...

Saj,

I noticed the company had a stock split on 12/31/07 and then a reverse split on 5/15/08??? that seems a bit odd. any idea why?

ak said...

Hey Saj, for most of these micro cap stocks, do you factor in volume for your risk analysis? I mean even 10k worth of shares maybe hard to dump when you reach target value.

Also at what point would you consider a company too risky due to (not sure how to phrase this correctly) the fact the chairman owns too much of the company?

Zachary said...

Doesn't this company have really bad operating cash flow? I think that has something to do with the low p/e. I haven't looked in a long time so I could be wrong.

Jim said...

Zack,
The company's operating cash flow looks reasonably strong: $11.1m in 2009 relative to $13.2m in net income and $5.6m in Q1 2010 relative to $3.2m in net income.

However, I did catch a red flag. Their auditor, Davis Accounting Group, P.C. has apparently allowed their license in Utah (where they are based) to expire. See link here:

https://secure.utah.gov/llv/search/detail.html?license_id=3599263

Zachary said...

Thanks Jim. All I could remeber was thinkng there were signs that it wasn't that great of a deal despite the first glance looks.

Saj Karsan said...

Hi ak,

Volume doesn't really enter the equation for me. Public or illiquid or private, I'm just looking to buy businesses at a discount.

I will usually view more inside ownership as a good thing, the caveat being in a situation where there's a dual-class share structure, because that can hurt smaller shareholders. However, I recognize insider ownership can also prevent a company from being acquired, but overall I think its a good thing due to the nice alignment of management and shareholder interests.

Saj Karsan said...

Hi Paul,

Interesting question. I have no idea...perhaps to comply with exchange rules (some require a certain volume, some require a certain price level)...maybe they were trying to comply with two different exchange rules in a volatile environment that was altering the situation requiring two different changes.

emiliano_s said...

I think jada business is very interesting with pretax margins around 70%, above 3 millon dollars of sales virtually all incremental revenue goes to profit.

one thing i would like to see is a real effort in improving the controls and procedures an issue with Chinese companies.

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