China Ding Yi Feng Holdings Ltd.

Quick: name a publicly traded stock that has gone up 8,500+ percent over the past 5 years. Do you immediately start thinking of Silicon Valley unicorns and IPOs that have occurred sometime since 2014? I know that’s the first thing I did.

It turns out that China Ding Yi Feng Holdings Ltd., which is an investment holding company that is listed on the Hong Kong exchange, has increased its stock price by more than 8,500 percent over the past five years.

The financials they release to the public don’t support the increase. Analysts that cover the Hong Kong market and China Ding Yi Feng Holdings Ltd. say there isn’t anything in the fundamentals that support the increase. They point to the fact that the company has posted losses in seven of the past eight years.

The crazy part is that with the 8,500+ percent stock run-up the market capitalization of China Ding Yi Feng Holdings Ltd. now hovers around $4 billion USD. At $4 billion USD it’s now large enough to be included in several indexes put together by MSCI, which means stalwart investment firms like Vanguard and Blackrock are now proud owners of its shares.

So what are the lessons here?

Market-cap weighted indexing has its limitations.

Ironically, its limitations may be one of its greatest strengths. Think about Amazon: indexes bought more and more Amazon shares even though Amazon didn’t turn a profit for years. A lot of people took a pass on Amazon because they didn’t think the fundamentals supported the share price. Those purchases by the indexes turned out to be justified as Amazon turned into a dominant, globe-spanning business.

The inclusion of China Ding Yi Feng Holdings Ltd. into an index may be similarly justified and it’s just too early to tell. However, it may just be a random series of events that is completely unrelated to the intrinsic value of the underlying business that has caused China Ding Yi Feng Holdings Ltd. to increase like it has and it’ll turn out to be a drag on the index’s future returns.

Investment holdings companies are notoriously difficult to value due to accounting rules and are further compounded when the accounting rules they’re using are not necessarily GAAP or IFRS.

US GAAP standards require that marketable securities be marked to market on a company’s books; however, wholly- or majority-owned businesses that are not marketable securities are not marked to market. As a result, the wholly- or majority-owned businesses can be massively undervalued. Same thing with other assets that aren’t publicly traded: they’re listed at the lower of cost or market.

To give you an example: imagine a company built a toll bridge 100 years ago for $100,000 (remember: $100,000 a 100 years ago was a lot of money back then). Due to accounting rules the book value of the bridge was amortized over a straight-line basis for 30 years. So 70 years ago, 30 years after the bridge was built, the value of that bridge on the company’s books was $0.

Today, the company collects $1 million in tolls every year and spends $100,000 on maintenance. They’re netting $900,000 per year on an asset that is carried on its books at $0. If you assume a 3% cap rate for the toll bridge (yay monopolies!), that bridge is worth $30 million. But you’d never be able to tell it from the company’s balance sheet.

So the question you have to ask is what accounting rules exist that are obscuring the true value of the company’s assets?

What if the 8,500+ percent run-up in China Ding Yi Feng Holdings Ltd. is just a freak bubble?

Let’s take the other side of the argument and posit that investors are acting irrationally for whatever reason. Maybe the run-up started because enough people bought into the cult of personality surrounding the chairman, Sui Guangyi, a Taoist scholar whose marketing materials claim he took the principles of Taoism and applied them to the markets with the result that his investing skills are on par with Warren Buffett and George Soros.

As a philosophy major myself, I’d like to help push that narrative. But as a Westerner I spent more time studying Descartes than the I-Ching.

The fact of the matter is that it’s incredibly rare to have intrinsic value increase by 8,500+ percent within 5 years. Heck, it’s incredibly hard for most assets to do that in a lifetime. At a 10 percent CAGR it would take 71 years to hit that kind of number. So when something shoots up 8,500+ percent in 5 years it means that the underlying assets were massively undervalued to begin with, you got lucky with a start-up, or you’re in the midst of a bubble.

Since the bubble is the more likely case with China Ding Yi Feng Holdings Ltd. the first idea most traders will have is to short it.

The Hard Part About Shorting China Ding Yi Feng Holdings Ltd.

Take a step back and pretend that you heard about China Ding Yi Feng Holdings Ltd. four years ago. It hit your radar after trading at 0.42 HKD per share on March 6, 2015. For seemingly no reason that you can discern China Ding Yi Feng Holdings Ltd’s stock price had shot up 56 percent in a year. The fundamentals back in 2015 didn’t appear to support the spike so you decide to pull a Dan Loeb and short the stock without any regard to price action.

You may have been absolutely correct that the fundamentals did’t support the stock price. But you still would have gotten murdered as the stock price of China Ding Yi Feng Holdings Ltd. went from 0.42 HKD to 23.05 HKD today.

Wait wait you say, at 23.05 HKD it’s even more overvalued today. I have an even better margin of safety so I definitely need to short it now!

That may be true, but there’s nothing that says China Ding Yi Feng Holdings Ltd. won’t continue its run, either from mindless buying by indexes, mindless buying of people who have bought into the cult of Sui Guangyi, or maybe there’s an actual underlying asset they own hidden from obvious view that supports their stock price.

So you’re better off remembering the advice of Whitney Tilson: it’s better to wait to short a stock until it has gotten cut in half, it has disappointed investors, and all the fast money has moved on.


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