Boy, am I glad to put 2011 behind me! It was a tough year for nearly everyone. This was only the second time since 2002 that GCM incurred a loss (the other year being 2008). In 2011, the DOW (at the last moment) ended the year in positive territory. However, if you strip away a handful of stocks (IBM, McDonalds), the DOW, S&P500, etc. suffered a terrible year. The vast majority of worldwide equities suffered double digit losses. It was a couple of weeks in August and September that turned our year upside down. The European crisis, the downgrade of U.S. debt, and worldwide political turmoil eventually took their collective toll. The positive take-away: It was mostly macro/global events that ruined our year, not company specific news. In 2011, many companies’ balance sheets vastly improved and the U.S. economy began to grow again.
A wise man once said that financial markets make decisions- and act – when political leaders don’t. Sound familiar?
Human beings are designed not to think in terms of uncertainty. If they think it is a good stock, they think there is a 100% chance that it will end up being a good stock. If they think it is a bad stock, they think there is a 100% chance that it will end up being a bad stock. What this means for investors is that ‘good’ stocks are overbought and ‘bad’ stocks are oversold. There is never a 100% chance of anything, so you want to go where all these factors lead you – look for ugly, disappointing and diseased securities where you have a sense that the disease is more than built into the stock price, which ultimately means cheaper. This is the first thing that distinguishes a value investor. However, being a value investor comes with quite a bit of pain and much patience. This is why I am excited for 2012 to unfold. There was a lot of disease built into many 2011 equities.
Even a mediocre company can become a worthwhile investment if purchased at a suitable price. After all, its share price already anticipates that it will continue to plod along, and a simple return to normalcy will surprise investors. The converse — purchasing well-performing companies at relatively high prices — does not necessarily hold true in terms of a sound investment philosophy.
As Kipling urged, it is most important “to keep your head when others are losing theirs.”
Here’s one about which we should keep our heads on straight…. In a continuing effort to highlight at least one of our companies, the following discussion relates to AXT Inc (AXTI). AXT was founded in 1986 and is headquartered in Freemont, CA.
AXT designs, develops, manufactures, and distributes semiconductor substrates (the physical material upon which a semiconductor device, e.g. an integrated circuit, is applied). They are a material provider for the fast-growing smartphone, wireless, fiber optic and solar cell industries.
The key point for investors to take away is that although AXT is currently priced as a diseased entity, it is not by any means a mediocre business. Aside from the fact that the company is coming off its best consecutive four-quarter performance in its entire operating history, what else does the market seem to be missing?
Two of AXT’s key end-markets – smartphones and satellite and terrestrial solar cells are projected for huge growth over the next several years. AXT is well situated, with re-established customer confidence, to take full advantage of the terrestrial solar cell growth that the sector will experience through 2015 and the estimated 1 billion smartphones expected to be sold in the same year.
AXT has made very smart strategic investments in five Chinese raw materials companies. Not only do these JVs grant the corporation continuous access to rare raw materials, but it also allows AXT to take advantage of favorable pricing terms. Germanium and gallium, both used in the production of AXT’s semiconductor substrates, were both labeled “critically rare” by the European Union and have experienced 28% and 58% price appreciations per kilogram respectively, over the past year. Such a favorable raw material arrangement has given AXT a substantial advantage over the competition in the recent past and will continue to do so going forward.
Nearly 16% (30,000 square feet) of additional manufacturing space in AXT’s Chinese production facility will allow the corporation to expand operations in the key markets that emerge as the most profitable in the near future. Utilizing its flexible manufacturing set-up, AXT was able to increase germanium substrate sales 65% between 2009 and 2010, and has already earned about 97% of 2010’s germanium sales in the first three quarters of 2011 alone.
The compound semiconductor substrate sector is guarded by extremely high barriers to entry and a long and strenuous process to qualify products. It appears on the surface that the market expects AXT to stumble as it has in the past. However, with its newfound commitments to quality, its strong stance in the compound semiconductor sector, impressive earnings and balance sheet, and the huge growth that several of its key markets will experience in the near future, the attractiveness of the opportunity cannot be understated. AXT closed 2011 at $4.17/share. The high and low in 2011 were $12.23 and $3.63 respectively. Seeing that they will complete their best year in the company’s history yet are 2/3 off their high, have roughly $1 per share in cash with no debt, strong market demand for the next few years, low cost manufacturing, etc., GCM (at these levels) will be a net acquirer in 2012.
Investing money is like sex: Passions makes fools of the cleverest men and can sometimes make a fool feel clever. We should remember this old French aphorism in times of market stress and volatility.
Goldberg Capital Management is an investment adviser registered with the State of CT Department of Banking. This Newsletter and its contents are for informational and educational purposes only. You alone will need to evaluate the merits and risks associated with the use of the information provided herein. Although this Newsletter may provide information relating to approaches to investing or types of securities and other investments you might wish to buy or sell, no information provided in this Newsletter is intended or should be construed as an investment recommendation or endorsement from Goldberg Capital Management. Please remember that past performance is no guarantee of future results.