Zuoan Fashion Ltd (ZA): A No-Brainer For Big Returns

Just took a long position in Zuoan Fashion, Ltd. (NYSE: ZA), opportunities like this come few and far between. Not far from its IPO back 2011, Zuoan Fashion is a design-driven fashion menswear company in China that has taken a beating for no apparent reason.

The No-Brainer Aspect

The reason to me this is a no-brainer investment is because while the company is currently priced at $2.17/share, a quick look at their balance sheet in 2012 shows they have $5.96/share in net cash alone (cash minus debt). Furthermore, if we take all the current assets and pay off all outstanding debt, we're left with $11.79/share. What this means is that if the company liquidated everything tomorrow, that's how much shareholders would receive per share, which makes this a textbook Buffet/Graham/Klarman value play with a 82% margin of safety. Wow...

And the story gets better. The company has no long-term debt and no short interest whatsoever. Below is my analysis of the fundamentals versus the stock price over a 5-year period:

Zuoan Fashion Quality of Earnings Vs. Stock Price (2008-2013)

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So what we have is a company who's fundamentals are clearly growing stronger over time while the stock price is diverging to reflect the opposite. No financial shenanigans here either, their financial reports were signed off by Crowe Horwathe, one of the top 10 auditing firms in the United States. Zuoan is essentially like a straight-A student in a bad high school, the top institutions are overlooking her just because she's small and didn't go to Harvard Academy. Their loss...

Not only has their fundamentals improved, but their ability to self fund with cash is getting stronger too (defensive), which means they can weather any storm that may lie ahead because their industry is so competitive.

Industry Recognition

So what about the company? Well, the fashion industry is highly fragmented. While the company has no defensible competitive advantage against competition and its success is dependent upon its ability to recognize and create appealing fashion styles in the years to come, the company has received the #1 spot of fashion designers in China by Apparel Magazine two years in a row now, beating out major competitors such as True Religion, Ralph Lauren, Nike, Urban Outfitters, & lululemon, two times over. From the July 2013 issue of Apparel:

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And as apparel magazine mentions, they sponsor and are regularly featured on the Chinese equivalent of Project Runway, "Hello Gorgeous." What better marketing avenue could a fashion company ask for? As China's middle class grows, Zuoan's affordable fashion line stands to benefit which makes this not only a value opportunity, but a growth one as well.

Valuation

Baseline valuation is $9.08/share (assuming a 50% write-off of Accounts Receivable in a liquidation event), but if the trend continues I may hold on until $12-14, making this one a potential 6 or 7-bagger. Estimated time to value realization, 2 years, maybe even sooner.

All Humans Are Value Seekers

Kind of broad statement, but it’s simple and it’s true so think about that for a second: All humans are value seekers. For the last few years I’ve kind of been obsessed with the concept of value. Value can mean all sorts of things and doesn’t necessarily have to pertain to money. That being said value as it pertains to money can provide us good direction in defining exactly what value is. Whether we are buying a house for less than what it’s worth, or a stock, or jewelry or whatever, it’s obvious that value plays a big part in our lives.

Then why is it so hard to define what the value of something is exactly? In real estate, how are houses typically valued? Comparables. That’s because value is so elusive that we have to look at things outside of something in order to determine how much it’s actually worth. Kind of crazy when you think about it right? We’re determining how valuable something is not by looking at the thing itself, but by looking at other things. It almost sounds a little insane, but that’s the nature of value, there's an essence of relativity.

Humans by nature are value seekers, meaning that they are constantly in pursuit of things they perceive to be worth in excess of the price paid for them. Why does someone pay $250,000 for a Ferrari? Because the person perceives that the value of that Ferrari ̶ the prestige, the glamour, the stares of hatred from passerbys ̶ is all worth much more than $250,000 because if it wasn’t they’d go buy something else. How many times have you saw something you liked, found out the price of it and said “Nah, that’s not worth it”? That’s this value-seeking concept at work.

As social animals, we tend to gravitate towards people that we perceive to have high value. Unconsciously, the reason why we befriend someone or start a relationship with someone is because we perceive that the value we can extract from that person is worth well in excess of the value we must give to that person in return. When do relationships end? When people feel like they are giving more than they are getting back.

But the biggest takeaway about value is that even though value is real, it’s still only a perception. It’s a perception with justifications, but just a perception nonetheless. Think about how that can work to your advantage in your life or in your career. The value of anything is defined only by our perception of it. How can we guarantee success in business or our career? It’s simple: give more than you ask for in compensation. 

The concept of giving really comes full circle here sociologically, in the fact that a person’s true value is determined exclusively by how much they give versus how much they ask for in return. That’s why 50/50 is a losing proposition in any relationship or business deal, the result is net-zero ̶ no value.

It’s a crazy concept that I’m still wrapping my head around myself, but undeniable at the same time…

Value = Perceived Worth – Price Paid

Home Depot Your Next Great Investment

Say you have to buy some paint to add some pep to your livingroom, where are you going to go?

If Home Depot even crossed your mind (just in case you said Lowes), you've just realized the hedge to this investment. Right now, Home Depot is severely undervalued in relation to its long term prospects. The reason why its down is because home improvement projects took a dive when the housing market dropped. Why do home improvement if your not planning on selling anytime soon?

The fact of the matter is that Home Depot has a huge market share, contested only by Lowes. Its brand equity serves as a great hedge against long term risk exposure, in addition to the housing market already having been through the worst. And surprisingly, even though earnings are down for HD, free cash flow is at some of its highest levels even compared to years with stronger revenue growth. Management's refocusing on merchandising also will serve to lower expenses and capital expenditures to help that free cash flow figure grow.

As I step down from my soapbox, I will be adding this holding to both my own and my girlfriend's portfolios.