Buy Gold For 60 Cents On The Dollar? Here's How

StreetAuthority Network

After an exceptional five-year run, U.S. stock markets are now touching all-time highs. It follows that stocks here at home are not nearly as attractively priced as they were at the start of this run.

I'm not suggesting that the U.S. markets are going to collapse, but I do think that it is time to start looking around the globe for better valuations.  
  
One place to start looking might be China. While the U.S. markets have roared back from the financial crisis, the Chinese market is only at a third of its pre-financial crisis high.

Investing in a Chinese company isn't particularly hard. You don't have to go to the trouble to obtain direct access to the Shanghai market itself. There are plenty of Chinese companies listed here in the U.S.

One attractively valued Chinese stock I've been looking at is Kingold Jewelry (Nasdaq: KGJI).

For good reason, U.S.-listed Chinese companies have gotten a bit of a bad rap in recent years.  There have been several instances where investigative work by savvy short sellers has revealed several U.S.-listed Chinese companies as nothing more than frauds. Now-delisted companies like Sino-Forest and Rino International spring to mind.

So when investing in U.S.-listed Chinese companies, an investor has to be careful. For Kingold Jewelry, it's important to note that the company has a short interest (percentage of shares sold short) of less than1%.

That means that short sellers think Kingold passes the smell test and haven't targeted as a company whose shares are likely to drop. That is important to me because I don't have any interest in owning a heavily shorted Chinese company listed on U.S. exchanges.

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Kingold is a producer of 24-karat gold jewelry and ornaments with a diversified strategy. The company designs and produces thousands of products under its own label. Kingold sells these goods through major wholesalers, as well as through an established nationwide distribution network. 

In addition to its own branded products, Kingold makes a variety of custom products that are relabeled by some of the country's largest distributors and retail chains. By manufacturing both for its own line and for others, Kingold both maximizes and diversifies its revenue.

 

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  Kingold  
  Kingold makes thousands of products that are sold under its own brand and other labels across China.  

Now to the valuation, the reason I'm interested in this company. Any way you slice it, Kingold Jewelry looks exceptionally cheap.

Let's start with the balance sheet. Since Kingold is a manufacturer of jewelry made out of gold, the company holds a large amount of gold inventory at all times. As of its most recent quarterly financial filing, Kingold had a gold and finished product inventory valued at $163 million.  

Adding the value of that inventory to all of Kingold's other assets and then subtracting the small amount of liabilities gives Kingold a book value of $3 a share. Meanwhile, the current share price just under $1.80, less than 60% of that book value.

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Theoretically, Kingold could liquidate all its assets, pay off all its liabilities and be able to send each shareholder $3 per share in cash.

If Kingold Jewelry were to trade only at its current book value (which implies the actual business itself is not worth anything), the stock would have to increase 68%.

That seems like an exceptional bargain for a company that has assets that are made up mainly of a liquid and fungible commodity like gold.

Now let's look at the income statement. For the first nine months of 2013, Kingold had $20.4 million of net income, putting it on pace for $28 million of net income for the year. That means that at its current share price of $1.78, KGJI is trading at a price-to-earnings (P/E) ratio of 4. 

That's dirt cheap for any company -- especially for one that has been growing steadily and is expected to continue to grow.

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Kingold's share price could double from where it is today, and it would still be trading at only eight times what are rapidly growing earnings. It isn't often that you can say a stock could double and still be cheap, but that appears to be the case here.

One catalyst that could help remedy this undervaluation is the commencement of a dividend by Kingold, which the company has strongly hinted is in the near future. Seeing real cash come out of a U.S.-listed Chinese company would also help remove some of investors' usual concerns about Chinese stocks.

Risks to Consider: Kingold Jewelry sits on a large inventory of gold, so its book value fluctuates with the price of gold. There are also additional risks involved in owning Chinese companies, but with a short interest of less than 1%, Kingold seems to pass everyone's smell test.

Action to Take --> Buy shares of Kingold Jewelry for its inexpensive valuation and pending dividend catalyst. This stock could double and still not be expensive by traditional valuation measures.

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