China has rapidly become the second largest economy in the world – second only to the United States, and by some calculations the largest. As a result, China also has some of the fastest-growing publicly traded companies on the planet. Moreover, tariff negotiations between the United States and China have recently become a political football that has resulted in a softening of prices on several prominent China domiciled American depository receipts (ADRs). With this article, I will be covering 7 prominent China-based ADRs listed on either the New York Stock Exchange or the NasdaqGS Exchange.
Some of these companies have experienced significant stock price corrections so far this calendar year, and others have corrected more modestly. However, in recent days most of these companies have become rather hot commodities. Therefore, the question I’m going to attempt to answer is whether these stocks have become attractive after the dip, but unattractive after the recent rallies. Nevertheless, my true motivation behind producing this article is to also offer an important lesson on value investing that is often overlooked by many investors when dealing with volatile stock prices.
The Geometry of Winning and Losing
There is a geometric phenomenon that occurs during volatile stock price action. Instead of thinking in arithmetic terms, investors are best served by understanding the geometry of stock price action. A few simple examples will illustrate the important lesson that I am attempting to highlight. If you invested $1 and your investment fell by 25% you would now have an investment worth $0.75. At this point it’s important to note that this $0.75 now represents the money that you have available for investment. More importantly, you must also recognize that your future returns must be calculated on that $0.75 and not your original investment of $1.
As a result, for you to recover your loss and grow your $0.75 back to $1, you must earn a return of 33%. This geometric phenomenon becomes more dramatic the greater your percentage loss. To simplify for clarity, if you invested $1 and lost 50% of your investment, you would now only have $0.50 available to invest. To grow that $0.50 back to $1, you would have to earn 100% return on your $0.50. This geometric exposure to loss explains why Warren Buffett has been quoted as stating that the number 1 rule in investing is “never lose money.” Or as my own personal mentor often preached – “to win you must not lose.”
In my previous article titled “Are Fang Investors Playing the Role of Greater Fool’s?” – I addressed the power of compounding by presenting and discussing the Rule of 72. Compounding future growth is also a geometric concept, and the 7 China-based stocks I am covering in this video are expected to grow at very high rates. However, the power of compounding also works in reverse as I illustrated above. The point is simple and straightforward; at the end of the day investing is all about understanding and correctly dealing with the dynamics of the numbers. In other words, it’s equally as important to understand the geometric phenomenon of loss as it is to understand the power of compounding at high rates of growth.