Yesterday we wrote, “Stock Market Companion stock “runner” for December – “SHZ” or China Shen Zhou Mining Inc. turned higher today after a week of selling off.  We sold well over a week ago at approx. $8/share for a +54% return in a little over a day.  If this stock begins looking closely at $10/share we will consider a renewed investment – even if it is just for another day of strong gains.”

Today, subscriber “Jed” posted this question – “Can you help me explain why you would consider renewed investment once it reaches $10?  Is the $10 value a key milestone indicating momentum, or …  can you explain why its not a good investment today?”

You are right, Jed.  $10 is a key milestone relative to MOMENTUM.  Currently, SHZ falls into the category of an unusual momentum stock.  It was priced at $1/share back in October and cruised rather suddenly higher in December from $2.50 to above $10/share, before sinking back down into the high “$7’s” and stabilizing in the $8/share range.  So it has come a long way in a short period of time and this means –

1. There are still probably “early adopters” who got the stock in the lower single digits – before the big move in December – who would like to see if the stock pushes $10 again.  They are holding out for approx. $10 again.

2. There are “late adopters” who bought the stock on momentum near $10/share – who are now underwater on the stock – and would love to simply “get their money back” at approx. $10/share.

$10/share is essentially where the momentum stalled out.  Between today’s price of approx. $8.80 and $10/share the shareholders mentioned in points #1 and #2 sit and hope – as momentum possibly continues to dry up.

If the stock can attract fresh investors – in addition to existing shareholders who are hoping for more than $10/share, then it will be evident by the ability of the stock to move higher than $10 and CLOSE above it’s Jan 5th close of $10.24/share.

If we were to purchase SHZ today at approx. $8.8/share, we would be hoping for an increase in share price on a stock that is already UP approx. 780% in less than 6 months, WHICH HAS PERHAPS LOST ITS MOMENTUM and that has a minuscule number of shares available to the public and therefore can fall VERY HARD if further interest is lost in the stock.  In October the stock rose to approx. $4.60/share and sank back down to approx. $2.50/share.  In this particular case, the stock “came back” and roared higher, but most stocks of this type don’t do so… they simply stay down.  That is – stocks that remain in the MOMENTUM category.

If there is a REAL STORY behind this SHZ stock, then we will see buyers and sellers engage the stock here and gradually or maybe not so gradually fulfill the supply requirements of investors from #1 and #2 above, before moving higher.  The math on earnings that we did on December 29th suggest that the stock CAN go higher – IF the stock is not simply a flash in the pan momentum stock.

Here’s what we wrote then –

Shazam! for SHZ = China Shen Zhou Mining and Resources, Inc. (Ticker: SHZ).  The stock is now up over +40% from it’s close yesterday at $5.50/share!  That is a HUGE move in an extremely short period of time.  That’s a lot of fun for those SMC subscribers who own the stock.  The important question now is … Now what?

Let’s start with the numbers that we know –

1. The company is tiny.  This year’s revenue is expected to be $14.5 million; next year’s revenue expectation = $38 million.
2. The company has BIG growth.  $14.5 to $38 million growth in revenue = +162%.  In other words, this year’s revenue MAY almost triple by the end of next year.
3. Net income for 2011 is expected to be approx. $11 million.
4. There are approx. 28 million shares outstanding, of which 89% are not available for the public.  Shares available to the public may only be 2.5 million shares.  Friends, that falls in the extremely scarce category.  Of course this number can change dramatically at any time based on what the insider shareholders do.
5. Let’s take next year’s expected net income of $11 million and for simplicity sake call it net earnings.  Therefore $11 million / 28 million shares = $0.39/share earnings.  At yesterday’s closing price of $5.50/share, this company was selling at $5.50/0.39 = 14.1 times earnings.   In other words, its price/earnings ratio (P/E) based on these numbers that we have to work with appears to be 14.1 (yesterday).  The market average here in America is approx. a P/E of 16.  Therefore the stock was selling yesterday at a good discount to the market.  At today’s momentary price of $7.60/share, the P/E has now advanced to 19.5 = a premium to the market.
6. Companies that have +162% revenue growth rates are “allowed” to sell at a premium to the market.  Sometimes this premium can be huge.  As a rule of thumb, some investors say that as long as the growth rate exceeds the P/E ratio, then the stock price may be ok.  Obviously in this case, this is a bit absurd.  To be more realistic, let’s look at what the price of the stock would have to be if it had a P/E of 30.  30×0.39= $11.70/share.  If for some reason the P/E went to 50, then the stock price would be $19.50.
7. At the beginning of January this year, the stock closed at $0.94/share.  As we write this, the stock is currently at $7.67/share.  That’s a 715% return for some shareholders in this one year.  Some people are going to soon want to capture these profits by selling their stock. From a different perspective, from our data it appears that this stock opened on approx. 2/25/2008 on the AMEX and closed that day at $9.04/share.  At $7.67/share, the stock is still -15% off its highs in 2008 and has another +17.8% more to go before it comes to that value.
8. Here are some points that make this stock unusual…
   Unusual in this case is the fact that such few shares are available to purchase.  Additionally unusual is the fact that this company is so tiny and doing business in such a remote corner of the world, yet available for sale to the investing public on the American Stock Exchange.  As an American Stock Exchange company, we have no other choice than to rely on the company’s financials and consider that they must be at least reasonably accurate.

Let’s add into the mix the idea that China is ratcheting down mining output.  Prices – in this case for fluorite have recently doubled.  Let’s add the idea that we are at the end of the year and very occasionally there are stocks that go “silly” in the absence of the normal checks and balances of a marketplace with full attendance of the investors and traders.

All of these things point to a convergence of unusual conditions that is resulting in this stock going ballistic.

1. Strategically and from a matter of principle it’s important for the SMC as a shareholder to make sure that we set stops along the way that allow us to capture gains, yet give the stock room to breathe.  For us personally, we are willing to give this stock down to $6.50/share. We have our stop set just below that number.  As an common stock investor, one of our primary objectives is to do all we can to make sure that we avoid turning a profitable position into a loss.  That’s why we use stops.
2. So far today, we like how the stock has shot higher, AND there hasn’t yet been a huge number of sellers immediately driving the stock below $7/share.  This could change at any time.  Yesterday we wrote, “It’s shares outstanding at approx. 28 million puts it in our experience in a categorical “sweet spot”.  It can really move UP when investors get behind it AND it can sink like the Titanic when investors decide to cash in their profits.”.  When sellers do come to take their profits, on this stock it will feel like the sky is falling.

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Please remember – at the Stock Market Companion we do not and cannot give individual investment advice. According to the State of Washington RCW21.20.005 the Stock Market Companion is not a Registered Financial Advisor and we do not render any advice on the basis of the specific investment situation of a particular individual. This information is for a wide readership and is not intended for any particular individual,  and under no circumstances should our Market Update or Watchlist be considered an investment recommendation or plan for any specific individual.  By accessing this material, you agree that the Stock Market Companion will not be held liable for any actions taken by a subscriber or other parties.  Please seek the counsel of a broker or other licensed investment professional for accurate pricing and concerning the suitability of all investments that you may be considering. Disclosure : You understand that the Stock Market Companion holds positions in the above mentioned securities.  Based on market related or personal events these positions may change without notice.

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