PSB Portfolio Update November 2010

| November 16, 2010

November 16, 2010

A Tale of Two Novembers

This year has been full of surprises.  The markets have been anything but predictable. We’ve seen our share of ups and downs.

Whatever expectations you may have had for the market can pretty much be thrown out the window.

For example, we’ve all heard how September and October are traditionally tough months for the stock market.  Well… not this year.  In fact, from the beginning of September through early November, the S&P 500 jumped nearly 17%.

That’s an impressive couple months for any time of year.

But just when we thought the market was out of the woods, the situation changed again.

Over the last week, the major market indices have been dropping.  As of this writing, the S&P 500 has fallen 4% from its November high.  And the Russell 2000 is down over 5%.

So what’s going on?

To start with, the market climbed ahead of two important events… QE2 and the mid-term elections.

If the Fed’s goal was to prop up the stock market, they couldn’t have done a much better job than what they accomplished with QE2.  The promise of billions of dollars of liquidity injected into the economy has been a boon to the market.

With QE2, investors stopped worrying about a crash.  More importantly, they started to feel comfortable investing in stocks once again.  This really drove the equity markets higher.

And that’s not all…

Mid-term elections also provided a measure of comfort to investors.  The expected Republican victories in Congress were seen as a big time positive for stocks.

You see, investors are betting Republican policies will be more favorable to corporate bottom lines.  Not to mention, the Bush tax cuts are almost certainly going to be extended.  And everyone loves tax cuts.

Unfortunately, the good times couldn’t last forever…

Once QE2 and the Republican election victories became a reality, there was nothing more to keep driving the stock market higher.  A news vacuum developed and upward momentum waned.

And then came bad news out of China… inflation’s rearing its ugly head.

Out of nowhere, China was forced to raise interest rates.

It really spooked investors.  Many are worried China’s rapid growth may turn into potentially dangerous inflation.  And they’re skeptical China’s Communist government can engineer a soft landing for the high-flying economy.

But we’re not buying the bears’ gloom and doom scenario.

Even if China’s economy slows, it should still grow much faster than any other major economy.  It should also be strong enough to keep driving the global economic recovery. And most importantly, it should continue driving growth for the Chinese companies in our portfolio.

Still not convinced?

Don’t forget about the mid-term election’s historically positive impact on the market. According to the Wall Street Journal, “the Dow has gained an average of 17.1% in the year following a mid-term election.”

It remains to be seen which November will ultimately prevail.  But we’re betting any market downturn will just be a temporary pause in this historic bull run.

Now, let’s take a look at the position updates…

Position Updates

Please Note:  We don’t necessarily update every open position each month.  We focus on the positions experiencing significant news, notable price movement, or a change in recommendation.  Please refer to the Performance page on our website for our current buy, sell, or hold recommendation for any positions not mentioned in the Update.

. . . . OMNOVA Solutions (NYSE: OMN) – Sell

OMN has made terrific gains over the past two months.  A strong upward move in the Chemicals industry helped drive the shares higher.

We’re now sitting on gains of over 18%.  And I know many of you have made even bigger profits.

Right now the shares are trading at the top end of a very wide trading range.  We’re not going to risk riding the shares down for another test of the lower trendline.

Let’s take advantage of the recent rally and exit the shares with a nice profit.  Go ahead and book your gains of 18% or more!  Congratulations on a nice winner.

. . . . Winner Medical Group (NASDAQ: WWIN) – Sell

WWIN appeared to have turned a corner in early October.  The shares were moving higher in what looked like a solid new uptrend.  Then disappointing fiscal fourth quarter earnings derailed the stock.

Revenue barely increased year over year due to slower sales in Europe.  And the weak quarterly sales caused the company to miss their revenue target for the year.

Profitability also increased less than management’s guidance.  Sky high cotton prices drove up raw material costs significantly.  And the weak dollar combined with a stronger Yuan led to unfavorable currency exchange rates.

The company reiterated a strong growth outlook for fiscal year 2011.  But we’re skeptical they’ll be able to deliver on guidance.  It’s time to exit WWIN.  We see plenty of better opportunities in the penny stock space.

Sell WWIN now to free up capital for much better opportunities.

. . . . China Gengsheng Minerals (AMEX: CHGS) – Sell

This trade has not worked out like we thought it would.  We were expecting the company to sign a number of lucrative sales contracts for fine precision abrasives.

But we’re not yet seeing heavy demand for this product.

In addition, the company’s main business – monolithic refractories – has been declining.  A slowdown in China’s steel making industry has led to a fall in refractory sales.

Unfortunately, big growth in fracture proppant sales has not been enough to counter the decline in refractories.  And with fine precision abrasive sales not materializing, it doesn’t look like sales and earnings are going to pop anytime soon.

Another problem is rising general and administrative expenses.

Despite the lack of growth this year, the company has increased salaries for senior management.  We’re not too fond of rewarding management when they’re failing to grow the company.

Given these issues, we’re going to use the recent surge in stock price to exit the position. Go ahead and sell CHGS to free up funds for opportunities with better profit potential.

. . . . Tianyin Pharmaceuticals (AMEX: TPI) – Sell

TPI had another great quarter.  Revenue surged 64% to $22 million.  Net income rose an impressive 68% to $3.7 million.  And earnings popped 50% to $0.12 per share.

But the shares aren’t moving meaningfully higher on the news.  For some reason, investors just aren’t pushing this stock to a more reasonable valuation.

We’ve waited long enough for this trade to take off.  Let’s go ahead and sell our shares now.  We have much better opportunities for our capital in other penny stocks.

. . . . LJ International (NASDAQ: JADE) – Hold

JADE knocked another earnings report out of the park!

Here’s a quick recap of the company’s third quarter numbers.  Revenue jumped 36% to $35.7 million.  Excluding a one-time gain, net income soared 191% to $3.2 million.  And earnings rose an impressive 140% to $0.12 per share.

Another fantastic quarter any way you slice it.

JADE’s aggressive expansion strategy is behind the rapid growth.  The company has opened an astonishing 32 new ENZO stores over the past 12 months.  That brings the total number of ENZO stores to 124.

And as a result, ENZO division sales surged 83% last quarter.

What’s more, this rocket-fueled growth should continue next year.

Management has secured financing to open another 60 stores in 2011.  These additional stores will allow JADE to take advantage of growing demand for ENZO jewelry.  And they’ll help JADE grab a bigger chunk of China’s rising disposable incomes.

However, new stores aren’t the only thing driving JADE’s phenomenal growth.

Sales at existing stores are rising steadily as well.  Last quarter, same-store sales jumped 13%.  A clear sign the ENZO brand’s popularity is exploding.  And if you’re still not convinced, a recent survey in Shanghai showed ENZO is one of four most desired luxury brands in jewelry.

The outlook for next quarter is more growth ahead…

Management’s expecting a revenue increase of 8% to $42.5 million.  And earnings are forecast to jump 44% to $0.13 a share.

I know I’m starting to sound like a broken record… but JADE shares are up big again this month.  The stock hit a new high of $5.68 giving us a superb 114% gain!

With the company firing on all cylinders, continue holding JADE for bigger profits.

. . . . MFA Financial (NYSE: MFA) – Hold

MFA has broken out of a year-long sideways pattern to the upside.  Two things are driving the stock higher… Strong quarterly results… And the Fed’s second round of quantitative easing (QE2).

Here’s a recap of the company’s third quarter results…

Through shrewd asset management, MFA continues to earn a solid spread on their bond portfolio.  Net income jumped 16% to $75 million.  And earnings increased a solid 8% to $0.27 per share.

Clearly, MFA is using just the right amount of leverage to generate nice returns for shareholders.

The Fed’s QE2 really bodes well for the shares.

Under QE2, the Fed’s going to buy another $600 billion of government bonds in addition to already planned purchases.  This means interest rates are certain to stay low for the foreseeable future.

This is great for us.

Remember, MFA makes money on the spread between low-interest short-term borrowing and purchases of higher yielding longer-term bonds.  The more money they make on the spread, the bigger the dividends they’ll pay out to shareholders.

With these two strong winds at MFA’s back, it’s no wonder investors are driving the shares higher.

Thanks to the recent share gains and quarterly dividends, we’re now sitting on gains of over 100%!  That’s an amazing return on a REIT in just two years.

Given the favorable outlook for interest rates, let’s hang on to MFA.  We should see greater share price gains, and we keep collecting the fat quarterly dividend in the meantime.

. . . . Nova Measuring Instruments (NASDAQ: NVMI) – Hold

NVMI is on fire!

The company just reported another record quarter.  The shares jumped to anothernew high of $7.29.  And we notched yet another peak gain… this time an impressive 68%.

Here’s a quick recap of the company’s third quarter numbers…

Revenues skyrocketed to a record $24.2 million… an amazing 112% leap over last year, and a 25% increase over the second quarter.  What’s more, net income jumped to $7.3 million.  That’s an eye popping 329% increase!

What’s going on?

Business is not just good… it’s booming!

NVMI just added two new foundry customers and one new memory customer.  Plus, customers are installing the company’s integrated metrology systems at the fastest pace ever seen.  Some are even installing dozens of tools per fab.

And that’s not all…

Management is very excited about the company’s prospects.  According to CEO, Gabi Seligsohn, the company’s “combination of new products and the recent customer design wins will support further growth in the future.”

That sounds like great news for us.  Let’s hold on to our shares of NVMI.  We’re expecting even bigger gains ahead.

. . . . Group (NASDAQ: WWWW) – Hold

WWWW continues marching higher.  The shares jumped to a new high of $7.37 on strong earnings.  That gave us a stellar 62% gain.

Here’s a recap of third quarter results…

Revenue rose 25% to $32.1 million.  Net income increased 29% to $5.3 million.  And earnings surged 33% to $0.20 per share.

What’s more, earnings beat estimates of $0.13 per share for a 54% upside surprise.  Big earnings surprises like this usually mean one thing… higher share prices ahead.

And there’s no reason the shares won’t go higher…

Net subscribers tripled second quarter levels.  Customer churn declined from 2.9% in the second quarter to a low 1.7%.  And the company paid down $6 million in debt months ahead of schedule.

WWWW is clearly firing on all cylinders.  Let’s continue holding the shares for bigger gains.

. . . . China Valves Technology (NASDAQ: CVVT) – Hold

CVVT is on a tear!  The shares surged to a new high of $12.64.  That’s good for a hefty 58% gain.  Not bad for our first six weeks in the trade.

Strong third quarter earnings are pushing the shares higher…

Revenue nearly doubled to a record $55.3 million.  Net income soared 318% to an impressive $15.9 million.  And earnings almost quadrupled to an amazing $0.45 per share.

Now that’s what I call a fantastic quarter!

Three things are driving growth at CVVT.

Two newly acquired subsidiaries contributed $23.5 million to revenue.  The Chinese government’s rapid infrastructure investment is boosting demand for the company’s valves across the board.  And CVVT is expanding quickly into the petrochemical, oil and gas, and nuclear power markets.

And this is just the beginning…

In light of the strong growth drivers, management upped revenue and earnings guidance. For 2010, they’ve increased earnings guidance from $40 million to $47 million.  And they’re targeting 30% revenue growth for 2011.

Following management’s lead, analysts have raised estimates for this year and next. They’re now forecasting 2010 earnings of $1.28 and 2011 earnings of $1.49 a share.

We’re more confident than ever the shares will hit our target of $14.40 over the next twelve months.

With the shares trading above our buy up to price, we’re moving CVVT from Buy to Hold.  Let’s hang on to our shares for even bigger gains.

. . . . ZST Digital Networks (NASDAQ: ZSTN) – Hold

Great news from ZSTN!

The company reported another quarter of strong growth.  Here’s a quick summary of third quarter numbers…

Revenue increased a solid 35% to $38.5 million.  Net income soared 95% to $6.4 million. And earnings popped 41% to $0.55 a share.

Strong growth across all lines of business drove results.

The outlook for next quarter is more high-powered growth.

Management’s expecting revenue of $35 to $41 million.  And they’re forecasting net income of $5.5 to $6.5 million ($0.47 to $0.56 per share).  That’s potential growth of 16% to 35% in revenue and 47% to 75% in earnings.

Another strong quarter should drive the shares higher.

Speaking of the shares…

ZSTN fell the day it reported earnings.  A hedge fund with a short position published a hatchet “research” piece the day before earnings.  It was filled with all the usual innuendo of financial shenanigans without any proof to back them up.

This was clearly a carefully timed “short attack” on a terrific company.

Unfortunately, the shorts drove the stock down initially.  But reason prevailed, and the bulls ultimately drove ZSTN up to a new high of $8.48.  That gave us a solid 31% gain on our position.

Given the company’s strong growth outlook, we recommend holding ZSTN for greater gains.

. . . . China Marine Food Group (AMEX: CMFO) – Hold

CMFO had another great quarter!

Seafood snack sales led the way with organic growth of 31%.  Sales of “Hi-Power” beverages once again beat management’s expectations.  And the company stocked up on fresh marine catch for the fourth quarter’s usual big selling season.

Here’s a quick rundown of the numbers…

Revenue surged 69% to $22.7 million.  Net income increased a solid 29% to $4.2 million. And earnings were flat at $0.14 per share.

Usually flat earnings would be a red flag.  But in this case it’s entirely understandable.  The flat earnings were a direct result of the company giving away cans of Hi-Power to promote the new drink.

This is a time-tested strategy in the beverage industry for jump-starting sales of a new product.  We’re betting the short-term hit will lead to much bigger Hi-Power sales in future quarters.  And those higher sales will help drive bigger earnings increases.

The outlook for next quarter is for more strong growth…

Analysts are expecting revenue to surge 68% to over $41 million.  And they’re forecasting earnings growth of 11% to $0.20 per share.

And if CMFO hits these numbers, they’ll have fantastic numbers for all of 2010.

Analysts are estimating revenues will rise 60% to $111 million.  And earnings are expected to jump 27% to $0.76 per share.

This is terrific growth no matter how you slice it.  With growth like this, we should see the shares make some big gains in the months ahead.  Continue holding CMFO for better profits.

. . . . Rodman and Renshaw (NASDAQ: RODM) – Buy up to $3.21

RODM has been on quite the rollercoaster ride.  The shares quickly jumped to a high of $3.33 after we got in.  That gave us a nice 16% gain in just about a week.

The shares then pulled back a bit with the broader market.  But now they’re moving up again and are headed in the right direction.

As expected, third quarter earnings were below last year’s levels.  But the company has done more deals and raised more money than at this time last year.  And more importantly, management says business is picking up.

According to RODM’s CEO, the company’s seeing increased demand for its core products including both PIPEs and IPOs.  Rising demand, along with improving market conditions, is sure to drive revenues – and the share price – higher in the coming months.

And that’s great news for us.

If you haven’t done so, grab your shares of RODM now.  Get in before the shares really take off.

. . . . Summer Infant (NASDAQ: SUMR) – Buy up to $8.00

SUMR is setting up nicely for a big move higher.  As expected, the shares pulled back a bit on earnings.  But don’t worry… short-term fluctuations are to be expected.

Keep in mind, SUMR shares have soared this year.

People were bound to take profits at some point before year’s end.  When the company barely missed earnings and very slightly lowered guidance, it gave investors an excuse to sell.

And that presents a great buying opportunity for us…

SUMR’s earnings are solid.  Third quarter earnings would have been right on target except $2-3 million in sales got pushed to the fourth quarter.  We should see these sales in this quarter’s results.

And earnings estimates for the coming year are still plenty strong.  The company’s expected to earn $0.65 a share in 2011… a solid 35% increase over this year’s expected earnings of $0.48.

We’re confident SUMR can hit our price target of $10.92 over the next twelve months.  If you haven’t grabbed your shares of SUMR, now’s your chance.  Buy SUMR up to $8.00.

. . . . Mindspeed Technologies (NASDAQ: MSPD) – Hold

MSPD had a solid fourth quarter…

Product revenue increased slightly over third quarter levels to $44.8 million.  Net income soared 169% to $13.2 million.  And earnings more than doubled to $0.38 per share.

It truly was a terrific quarter.

In fact, it was the sixth quarter in a row of revenue growth.  And it capped off a year sporting 36% product revenue growth and record profitability.

However, the shares dropped after management issued lower revenue guidance for the upcoming quarter.  They’re now expecting an 8% to 10% drop in sales next quarter.

Keep in mind, there’s nothing wrong with the company’s business.

MSPD is just preparing for a temporary decline in orders from their largest customer,Cisco Systems (CSCO).  Cisco signaled last week they’re seeing a slight decline in demand for their products.

We don’t expect this downtick in demand to last very long.

Remember, MSPD’s chips are used by telecoms in building their next-generation wireless networks.  Any slowdown in these projects has to be temporary.  The wireless telecom business depends on building bigger and faster networks.

So, what do we do with our shares?

Here’s the key… we’ve already seen MSPD pull back on the news.  The damage is done, so to speak.  But the company is well positioned to ramp up when demand picks up.

What’s more, companies tend to exaggerate bad news.  By lowering expectations, they set up positive earnings surprises going forward.  And nothing drives shares up like an upside surprise!

We recommend holding MSPD for now.  Let’s give this fast-growing company time to work through what should be a short-term bump in the road.

. . . . Information Services Group (NASDAQ: III) – Hold

III continues moving higher.  The shares are now up 58% since late September.  Just what we like to see!

And I expect to see even bigger gains in the future.

III’s third quarter earnings showed several positive developments.  Most notably, sales growth in the Asia Pacific region spiked an impressive 66% year over year.  And growth in the Americas region continues to be positive.

What’s more, the company is grabbing market share.

For example, III just signed a two-year $4 million governance service agreement with a major transportation company.  This brings III’s total contract value under management to an impressive $8 billion.

And, management is optimistic about next year…

They see revenue growing as the economy keeps getting better.  And we see no reason to disagree.  III is firmly on the right track.  Hang on to your III shares for bigger gains ahead.

. . . . Ultra Clean Technologies (NASDAQ: UCTT) – Hold
. . . . FSI International (NASDAQ: FSII) – Hold

To save time, we’re going to cover these two chip equipment makers in one update.  They each just reported fantastic quarterly results.  And they’re both facing the same near-term headwinds.

Here’s a quick summary of each company’s quarterly numbers…

UCTT had record revenue and earnings in the third quarter.  Revenue surged 187% to $188.5 million.  Net income improved from a loss of $1.4 million to a stunning $6.7 million profit.  And earnings soared from a loss of $0.07 per share to a terrific $0.29 gain.

A super quarter any way you slice it.

FSII didn’t break any records, but their numbers were just as impressive.  Revenue more than doubled to $28.8 million.  Net income rebounded from a loss of $73,000 to an amazing $6.6 million profit.  And earnings roared back from break-even to a gain of $0.17 per share.

Again, a terrific quarter by any measure.

So, why did both stocks fall on the news?

They each lowered revenue and earnings guidance for the next quarter.  UCTT is expecting revenue of $110 to $115 million and earnings of $0.20 to $0.24 per share.  And FSII slashed their revenue guidance and forecast a net loss for the coming quarter.

After a furious buying spree over the past few quarters, chip companies are pausing to catch their breath.  They want to see if consumer demand for end products (computers, TVs, printers, etc.) continues moving higher.

Here’s the bottom line…

We’re expecting the drop in demand for chip equipment to be temporary.  The Fed is clearly doing everything it takes to keep the economic recovery going.  And when industry players see the economy is still improving, orders for chip equipment should pick up where they left off.

In the meantime, both managements are lowering expectations as far as possible.  It’s the oldest trick in the book.  By driving expectations into the ground, they set up potential upside earnings surprises in future quarters.

Let’s hold on to our shares of both companies for now.  We don’t want to bail out of the chip equipment recovery theme just yet.  As the economy heats up, we expect to see UCTT and FSII move significantly higher.

. . . . PLX Technology (NASDAQ: PLXT) – Hold

PLXT is in a similar situation to the two chip equipment companies above.  Remember, PLXT produces integrated circuits, particularly PCI Express switches.

Just like the chip equipment makers, PLXT had a terrific quarter.

Revenue jumped 40% to a record $30 million.  Net income recovered from a loss of $1.9 million to an impressive $1.1 million profit.  And earnings rebounded from a loss of $0.05 to a gain of $0.03 per share.

Record sales of PCI Express products drove the results.  And the company saw especially strong demand from market leading data center customers for the PCI Express Gen 2 switch.

Then management lowered revenue and earnings guidance for the next quarter.  This disappointed investors. And the stock moved lower.

Like the other two companies, PLXT is adjusting to an industry-wide slowdown.  And they’re jawboning revenue and earnings estimates as low as possible.  They know what upside surprises can do for the share price.

Again, we believe any slowdown will be temporary.

Once it becomes clear the economy is still recovering, orders for the company’s products will pick up again.  And when the company’s numbers show improvement, the shares should move higher in a hurry.

Hang on to PLXT for bigger gains ahead.

. . . . SMART Modular Technologies (NASDAQ: SMOD) – Hold

SMOD shares have been falling of late.  The selling began with a case of mistaken identity. A bad earnings report from SMART Technologies (SMT) was wrongly attributed by many investors to SMOD.

As if that wasn’t bad enough, a couple of analysts later came out with lower estimates for SMOD.  They’re saying a big drop in memory chip prices will impact the company’s top and bottom lines.

Nevertheless, consensus estimates haven’t budged.  This means most analysts are sticking to estimates based on the company’s robust guidance for this quarter and the year.

We believe most of the selling in SMOD is due to investors confusing the stock with SMT. And while some of it may be in anticipation of an industry slowdown, we believe any slowdown will be temporary.

Continue holding SMOD for greater gains ahead.

Action To Take

  • Sell OMNOVA Solutions (NYSE: OMN)
  • Sell Winner Medical Group (NASDAQ: WWIN)
  • Sell China Gengsheng Minerals (AMEX: CHGS)
  • Sell Tianyin Pharmaceuticals (AMEX: TPI)
  • Move China Valves Technology (NASDAQ: CVVT) from Buy to Hold

Category: PSB Portfolio Updates

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