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Fact vs Opinion and China Telecom

By Louis Llanes | September 21, 2018

When I was in college I had a professor in communications that really impacted me. This particular professor gave us an easy first assignment. He told us to pick up any newspaper we wanted and read it from cover to cover for an entire week.

By Louis B Llanes, CFA CMT
Founder, Wealthnet Investments, LLC 

Connecting Your Own Dots

When I was in college I had a professor in communications that really impacted me. This particular professor gave us an easy first assignment. He told us to pick up any newspaper we wanted and read it from cover to cover for an entire week. Our task was to underline only things that are facts and backed up by data or by a reliable source. It was a really interesting exercise. I chose the Wall Street Journal, I went through the entire week and highlighted only the facts.

I was astonished because less than 20 percent of the entire newspaper was actual facts. What that brought to my attention was that there is very little fact in newspapers and in the news in general; most of it is opinion or fluff. I also learned that each individual author is connecting dots and coming up with a conclusion.

This means you could come up with your own conclusions that may be different from what is in the news if you just highlight the facts and then connect your own dots. One of the things that I find to be extremely helpful in investment is to be that person who highlights the facts and then connects their own dots. Listen to what other people's opinions are, but don't necessarily take that as being the gospel truth.

Is It a Waste of Time to Consume News?

The reason I bring this up is that in the last few weeks, and throughout my career, there has always been a camp of people that say not to read or listen to the news, that it’s all worthless. I would say, for the most part, that is absolutely true. There are, however, a couple of caveats that apply to that.

The first is that there is a tremendous amount of information inside the news from a sentiment perspective. This means that we can get a good feel for what the prevailing bias is, get into the mind of the market, and watch the movements of the prices themselves.

If you see a variance between what the sentiment is and what the prices are doing, you have as potential setup for a significant trend change. That’s one reason to listen to the news - you can actually see these setups occurring. You can see these divergences between what the prices are telling you versus what the news is saying and what the prevailing opinion is.

One recent example of that would be the Bitcoin craze. When we saw that exponential move up, the prevailing bias was that the cryptocurrency was going to change the world. Meanwhile, we had a complete trend break and all technical indicators were flashing sell signals to get out. We then saw a massive drop in Bitcoin.

China Gets No Respect

A lot of times if you do your homework, you can look in a group and find investments that make sense from a longer-term perspective. I want to mention the emerging markets, specifically China, because we have this prevailing bias right now that nobody wants to own international or emerging markets.

Not long ago I had a phone call with a new, high net worth client that was coming in and we were looking at their entire portfolio. This client had virtually no international exposure and in the conversation, they said that it hasn't been the place to be, and that client was 100 percent correct. It was not the place to be and it hasn't been for quite a while, but that could be changing.

 

 

If you’ve seen previous market calls, you’ve likely heard about how emerging markets peaked a long time ago, and for that reason, there was potentially a value setup, but we needed to see some stability. While that is true from a general market perspective, from an investment management perspective, I believe that savvy investors can look inside the group and find opportunities to start nibbling now.

China Telecom – Growing In and Out of the Market

A company that I find especially interesting is China Telecom. It is the largest fixed line operator in China, covering 21 southern provinces. They have about 120 million fixed line subscribers, 141 million broadband customers, and 282 million wireless subscribers. The firm is increasing, it's cross selling across the product lines and they're adding additional services such as cloud computing.

Why this particular company? Simply put, they are trading at multiples that are substantially lower than what we would see in other investments. They have an earnings yield of around seven percent, whereas the general market earnings yields are substantially lower than that. They're growing at about nine percent according to what analysts are estimating, compared to other firms that are growing at a slower rate and have multiples that are not as attractive, and the stock has been basing for a long time.

 

 

This is a monthly chart from 2003 to the current year. Looking at this, you can see a long-term support area at $41-$42 per share, which was established with a peak in 2003, and has been tested multiples times. This particular stock peaked out in the nineties and now it's trading at around $48 per share. If you look at the volume weighted average price of the trading from that peak until now, you can see that we're testing that upper end of that range and the stock is oversold from a very long-term perspective.

The lower part of the chart is the Chaikin Money Flow indicator, which essentially shows you the money moving in and out of an instrument. Any technician can see that this stock is oversold and at support levels. I want to stress that when looking at the valuation, they have a competitive valuation compared to the industry and their top competitors. They also have that competitive growth; the firm has increased its wireless base by more than six times since it acquired the business in 2008, much faster than its competitors.

There’s a backdrop of sentiment where we have pessimism and Chinese stocks concerned about the dollar possibly being overblown. I believe that over time, a long-term investor can pick up these types of companies. Although, a whole country or asset class in emerging markets is not bottomed yet. This is where you can find some fertile ground for opportunity.
There are obviously some risks involved with this. China Telecom is controlled by the Chinese government, and their objectives may or may not be aligned with those of the minority shareholders and competitors.
Their competitors are marketing very aggressively and they have more scale. And of course, we have emerging market risks with currency and tariffs.
This is not without risk but taking a reasonable position size and keeping the risks in mind could turn the risk into opportunity.

 

 

Smaller Scale, but Still Competitive

This chart shows China Telecom on the top and one of their biggest competitors, China Mobile, in the middle chart. The bottom chart shows the relative comparison of the performance between China Telecom and China Mobile.

When that line is moving higher, China Telecom is outperforming China Mobile. Since July, we've seen that steady increase in outperformance there. Despite not having the scale of their larger counterparts, the market participants are showing indications that they’re buying for a few reasons.

One of the most probable reasons is that the relative performance is better than their top competitors since July. We’ve also had a significant support level that has been tested multiple times, and that would indicate potential for stealth buying.

 

Where Can This Company Go?

Let’s look at where this company could go. If we view it from a cash flow perspective, we've seen estimates from analysts that the fair value of that company could be as high as $82 a share with the stock trading around where it is right now. If we have a confirmation bullish move up, the stock would break above 51, which would be right around the volume weighted average price, and that could be a reasonable entry.

Obviously, there's no perfect knowledge that it is occurring, but we might have a higher indication of that happening. If that is the case, the stock could have the potential upside of about $31 a share. Looking at the volatility of the instrument and trend change, you're looking for downside risk of around $13 per share down to $38. That’s a reasonably good return risk profile.

So this is the kind of thing that I think investors can do within the context of a diversified portfolio. If you look at the relative strength of this stock compared to the S&P 500 on the bottom part of this chart, you see that the downtrend in performance is starting to slow now. So we've seen, you know, it's, it's just gradually slowing.

This is still in the early stages; it’s not a completed base. This would be an anticipation type trade where you're looking to be a little bit ahead of it and taking a smaller position size would make more sense.

Summary

In summary, when reading/watching/listening to the news, it’s important to notice how much it is fact versus how much is opinion. Identify the facts and connect the dots for yourself to form a more reliable picture. That being said, it doesn’t make sense to me to ignore the news entirely; it can be a very good indicator of sentiment that might not necessarily be evident otherwise.

China Telecom is looking good in the long-term valuation game. Despite being on a smaller scale, it’s outperforming larger companies. It’s beating out its other opportunities in both growth and valuation. Keeping the potential downsides in mind, smaller position sizes could turn risk into opportunity.

 

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