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Nam Tai Electronics, Inc. (NTE)

(December 2, 2004)

Again, readers are encouraged to exchange ideas and views on both our individual “stock picks” and our market commentaries. Please start posting in our Discussion Forum today!

Dear readers – as the market and the technically strong individual stocks get more and more overbought each day, it has been a very tough exercise in trying to find stocks that I think represent compelling buys. That is not to say that I don’t believe stocks in general won’t go up further – but rather I have always believed that one should always find the perfect psychological time to buy – that is, as close to the pivot/breakout point as possible.

There are good reasons for this. First of all, buying as close to the pivot point as possible lengthens your tolerance and holding time. For example, a leading stock that has already broken out of its resistance or base and has already moved up 15% can always decline back to its base before resuming its uptrend again. If you had bought at that level and had set a 10% stop loss on your original position, then you would have gotten sold out and would have missed out on the entire subsequent up move.

The logical argument to that would be: Why don’t we set a stop loss that is just slightly below the pivot point and ignore the fact that the stock is already 15% above its pivot point? That way, we will get protected on any false upside moves (since a stock that declines back to or below its pivot point usually means that the entire upside move was a false move) but can also enjoy the potential upside if the stock chooses to rise further. This is where the second reason comes on – risk management. When it comes to trading or speculating, one should always seek to maximize one’s profits and minimize one’s losses. This may be an extreme example but suppose you were on a losing streak (or the market was simply not “cooperating”) and you get stopped out on your trades ten times in a row? Buying as close to the pivot point as possible (say, within 5% instead of 15%) would minimize your losses quite significantly. Over time, the difference between compounding a 5% and a 15% loss is very significant – and losing 15% of your position (as opposed to 5%) in half the time that you trade (which is already a pretty good average) can also be a blow to your trading confidence. My point is: There are significant psychological as well as monetary costs when it comes to poor execution or entry points.

Right now, a lot of leading stocks or stocks that I believe have strong fundamentals are simply overbought – they have just been rising from their bases relentlessly – without either a significant correction or consolidation phase. Again, this does not mean that these same stocks cannot go up further but if one cannot initiate a position within 7 to 10% of the pivot point, then I believe one should just forget about it and wait for another opportunity (trust me, they will materialize in due time). Make no mistake – there are a lot of good stocks out there, but there really aren’t a lot that I believe provide good entry points for now. However, I have spent quite a bit of time over the last week or so looking for a potentially attractive stock and I believe I have found one. I will show you the technicals first since this is the primary reason why I selected this stock.

Following is a weekly chart with its 40-week moving average of Nam Tai Electronics, an electronics manufacturer based in Shenzhen, China – just 30 miles away from the Hong Kong and China border. You can read more about the company at the Reuters website. The company’s website is also very investor-friendly – you can read more about the company’s main customers and products right here.

As readers can see from the following chart, the stock is still right at a trend line that has provided major support for the stock back in April/May and August earlier this year. So far, the price action of NTE suggests consolidation on this trend line before embarking on the next up move. While there is a chance that this stock may break support and break out on the downside, I do not believe this will be the case – in light of my bullish views on the stock market and even more so on the semiconductor market.

Right now, we’re just playing the waiting game. However, please note the huge resistance line that has acted as resistance for the stock during the January/February and more recently the September/October period. Currently, we are about two dollars away from breaking out above this resistance line – as well as the 40-week moving average which has also acted as resistance over the last five months. Please also note that both the resistance and the support lines are soon about to cross – suggesting (technically speaking) that either a decisive upside or downside breakout is imminent:

Nam Tai Electronics, Inc.(NTE) 1) PPO turning positive? 2) Stock price right at support and resistance - which way will it break through?

Again, at some point, this stock should break out, and given my bullish views on the stock market and the continued improvement of the fundamentals of this company, I believe the breakout will be on the upside. The fact that the stock of this company has been making a base for the last eight to nine months is also telling me that the eventual breakout will have authority – and that any uptrend that emerges will be a sustainable one.

Let’s now discuss a little bit about the fundamentals of this company. In its latest quarterly earnings report released a month ago, the company reported a 48.1% increase in sales and 29.4% increase in operating income, relative to the same quarter in 2003. At the end of September 30, 2003, the company also reported a net cash (and marketable securities) position of approximately $4.66 per share – with only 20 cents per share of short-term and long-term debt outstanding.

Efficiency in operating the company has also increased, as: Debtor's turnover was improved from 86 days in the second quarter of 2004 to 54 days in the third quarter of 2004. Inventory turnover was improved from 11 times in the second quarter of 2004 to 15 times in the third quarter of 2004.”

So why hasn’t the stock performed well since the beginning of this year? There are a couple of reasons:

1) The stock has a huge 7-fold increase during the March 2003 to January 2004 period. The stock was consistently in the top five stocks on the IBD Top 100 list and it drew in a lot of daytraders and speculators. After such a speculative period, it usually takes awhile for the stock to recover – as it takes time to squeeze out the impatient daytraders and speculators out of the stock.

2) There has been a lot of concern regarding the increase of raw material prices and labor shortages in China. While these concerns are not unfounded, it is interesting to note that the company has continued to perform well despite these macroeconomic problems.

Technically, it looks like that the stock has had its share of consolidation (basically for the last ten to eleven months). In terms of valuation, the stock is attractive once again, and the rise of the semiconductor industry over the next twelve months or so should help this stock along as well.

It is also good to note that the management of this company has had ample experience in operating in China, as the company has been there since 1978. Management has also been on the lookout for any potential problems, as stated in the same earnings report: We are aware of the uncertainties in the market, such as the shortage of skilled labor in the PRC, the likelihood of RMB revaluation, and power supply shortages. The Company reviews these, and many other issues on a regular basis, and takes appropriate steps to safeguard itself and to mitigate the impact on our revenue. For example, our comparatively good wages and staff benefits has meant that we continue to enjoy low staff turnover. We have marketable securities denominated in RMB to help cushion the effect of a RMB revaluation, and our in-house treasury closely monitors foreign currency exposures. Our factories have their own electricity generating capability to ensure minimum risk to a disruption in the grid supply.”

Finally, the company is on track to complete its expansion plans over New Year’s – these expansion plans will more than double its current capacity and is expected to fulfill the company’s growth plans over the next two to three years. In the meantime, the company continues to seek other locations in order to meet its growth plans in 2007 and beyond. Readers should keep in mind that Nam Tai Electronics is an established company – and most likely is not expanding recklessly. Therefore, I believe the fact that the company is optimistic about the future growth of its products and the industry is a bullish sign for the stock.

Happy Trading/Investing!

Henry To, CFA

P.S. Please discuss this stock in our individual stocks discussion forum.

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