Thursday, December 15, 2011

EJ: Bear or Buffett?

Shanghai-based E-House (China) Holdings Inc (EJ) provide brokerage services, data and consultation to real-estate developers in China.

Although China's real-estate market has been soaring like a BRIC compared to the U.S., there have been recent signs that the market is softening, and analysts rate EJ negatively by a very large margin.

So EJ is a bear play for me. Yet, there is reason to think that EJ is a company that value players like Warren Buffett would favor (although Buffett, I'm sure, would never buy into an overseas company like EJ whose business details he wouldn't clearly understand).

The price action certainly confirms that. EJ's profile, in fact, is like that of any recession-beaten U.S. company, except more so.

It peaked at $36.45 in October 2007, declined to $4.00 in November 2008, rose again to $19.15 in August. 2009, and has declined every since, down to $4.43.

That gives a good 9.7% of free play before the price faces the challenge of bursting through support to a lower low.

The most recent higher high on the daily chart was Oct. 28, at $8.94, and the course of the price ever since has been relentlessly downward.

EJ's return on equity is 0.7%, so it is positive, at least, but still very much in the doldrums. Debt figures aren't available, which isn't unusual for companies beyond American shores.

The price is cheap -- 86¢ for each dollar in sales. That's a negative, of course, for a bear play. But a big plus for value investors.

Because, I think, a bullish case can be made for EJ. The low price/sales ratio makes it a reasonable candidate for a longer-term reversal strategy, once the price shows signs of turning up on the daily chart.

The company is said to have a great reputation for service and has won many awards for the quality of its product. I haven't gone into the financials in Buffett-like detail, but a superficial glance suggests that EJ may be a fundamentally sound company that has run into a rough patch and as a consequence is under-priced.

However, I'm a trend player, and the trend now is decisively down, including a sharp volume spike to mark Wednesday's  decline.

Average volume is 438,000 shares, which creates some logistical problems for traders. The stock is optionable, with a fine selection of strike prices at $1 intervals.

However, open interest is on the small side, and the price is under $5, which means it will take a lot of contracts to amass a decently large position. A $1,000 trade of the May $7 puts, with a delta of 74, would require 222 contracts. Open interest on that option: 32.

So the right way to play a smaller stock is to bypass options and short the shares. But, one of my brokers -- E*Trade -- says I can't sell short because they can't borrow the shares.

As a trader with a bearish opinion, I'm left on the horns of a dilemma: Should I buy puts and risk overwhelming an illiquid market? Or should I pass on the trade entirely?

The next earnings are scheduled for March. The stock pays an annual dividend of  25¢ -- more than 5% at the current price -- in April.

Disclosure: I decided against opening a bear position on EJ, because of the low liquidity, and hold no position in the company.

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