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Introduction
Trades
Sizing
Introduction
Don’t overthink it.
A lot of times, the best setups are simple. After all, the value of a stock at 4 PM is simply the price others are willing to trade with each other at. If your thesis is hard for others to understand it’s unlikely the market will see the same value you do.
I’m mixing things up for this week’s piece. Some of the best trades I’ve made this year weren’t predicated on a long winded thesis of “secret situation the market doesn’t understand”, but rather, “the stock just looks cheap”. Whether it was Heritage Insurance at four times earnings, or Brighthouse Financial at a 60-40% chance of being bought, or even perennial value trap OSB bumbling around at 5x earnings with a big buyback, the setups were simple.
This brings me to the land where cheap is, in fact, the norm: Chinese ADRs.
Despite the incredible run of Baidu and Alibaba, many of their smaller peers have entirely missed the recent rally. A few at 3-4x earnings with sizeable capital return programs are increasingly catching my eye, especially given their liquid options chains.
One of the largest risks when investing in Chinese ADRs is “zeroed” risk, that you wake up one day and discover your entire investment is gone, hence why the entire group tends to trade at a rock-bottom valuation.
Liquid options chains present an opportunity: the ability to dabble in these 3x - 4x names with strong capital allocation programs while hedging nearly all of your downside risk.
Many of these trades are still in the formative stages and I put on most yesterday, but I think the combination of rock-bottom valuations, strong capital allocation programs, aligned insider ownership, and options overlays that substantially eliminate downside risk present a few unique setups with 31% upside potential (if things go right) with just 11-12% downside risk. Without further huffing and puffing, let’s get into it.