Weekly Philippine Stock Pick

Last week I recommended EEI as a buy. I still recommend it this week. It looks poised ready for a move up in my opinion on a technical basis. I do look at fundamentals when selecting stocks to buy or sell, but I mostly look at the technical analysis and low risk high reward trade setups, as the price reflects all known and unknown information on a stock price in my opinion. Of course there are always exceptions to rules in the markets.

My scan of the Philippine stock charts this week has given me a buy pick that’s in the Philippine mining sector, and specifically gold.

It’s Lepanto Mining B Shares. Ticker LCB

Accumulate at current price levels of around P0.28.

Stop-Loss at 10% to 20% depending on your appetite for risk, and position size to you’re total portfolio equity. Remember to diversify your investments by spreading out your risk by not putting all your eggs in one basket, lest you trip and fall.

Take Profit Areas: Short Term P0.32 to P0.34. Intermediate Term P0.44. Long Term P0.54.

First I want to start with Lepanto’s stock rights they offered to existing shareholders between April 15 to 22, 2008. They offered existing shareholders the option to buy 7 shares for every 1 share owned, between these dates to be able to purchase shares at a discount to current market price at P0.25 per share. The market price during these dates was a high of P0.31 and a low of P0.29.

At Friday’s current close price of P0.28, the stock rights offer price at P0.25 is about a 10% discount.

A stock rights offering is the option given to the present shareholders to buy additional shares of stock at a price lower than its market price.

Stock rights are nice for new shareholders but bad for old stockholders as it dilutes the value of the earnings per share. Regardless of the dilution of EPS issue, I still think Lepanto has a good chance of going up from here, but be aware of this very serious issue, and read more about it below Lepanto’s company profile.

Lepanto Mining Company Profile

Lepanto Consolidated Mining Company (LCMC) is a Filipino primary gold producer. As a mining company, Lepanto has been a proud resident of Mankayan, Benguet, Philippines for 70 years since 1936. At present, it operates the Victoria and Teresa gold deposits. Its main office is located in Makati City.

Lepanto is a publicly-owned Company providing investors with highly liquid gold products. Its shares are traded in the Philippine Stock Exchange under the symbols LC and LCB. The company's issued and outstanding shares are 28.8 billion.

More Important Shareholder Stock Rights Information

The following provides a simple illustration of what happens when a company increases the number of shares issued, or shares outstanding, through a secondary offering.

Let's start from the beginning. A company goes public with an initial public offering (IPO) of stock. In our example, XYZ Inc. has a successful IPO and raises 1 million by issuing 100,000 shares. These are purchased by a few dozen investors who are now the owners (shareholders) of the company. In the first full year of operations, XYZ produces a net income of 100,000.

One of the ways the investment community measures a company's profitability is based on earnings per share (EPS), which allows for a more meaningful comparison of corporate figures. So, in its first year of public ownership, XYZ had an EPS of 1 (100,000 of net income / 100,000 shares outstanding). In other words, each share of XYZ stock held by a shareholder was worth 1 of earnings

Subsequently, things are looking up for XYZ, which prompts management to raise more equity capital through a secondary offering, which is successful. In this instance, the company only issues 50,000 shares, which produces additional equity of 50,000. The company then goes on to have another good year with a net income of 125,000.

That's the good news, at least for the company. However, when viewed from the point of view of the original investors - those who became shareholders through the IPO - their level of ownership has been decreased with the increase in the shareholder base. This consequence is referred to as the dilution of their ownership percentage.

Some simple math will illustrate this event. In the second year, XYZ had 150,000 shares outstanding: 100,000 from the IPO and 50,000 from the secondary offering. These shares have a claim on 125,000 of earnings (net income), or earnings per share of 0.83 (125,000 of net income / 150,000 shares outstanding), which compares unfavorably to the 1 EPS from the previous year. In other words, the EPS value of the initial shareholders' ownership decreases by 17%!

While an absolute increase in a company's net income is a welcome sight, investors focus on what each share of their investment is producing. An increase in a company's capital base dilutes the company's earnings because they are spread among a greater number of shareholders.

Without a strong case for maintaining and/or boosting EPS, investor sentiment for a stock that is subject to a potential dilutive effect will be negative. Although it is not automatic, the prospect of share dilution will generally hurt a company's stock price.

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