TM Editors' Note: This article discusses a nanocap company. Such stocks are easily manipulated; do your own careful due dligence.

I find the Takung Art Company (TKAT) interesting in terms of its business model, valuation, and growth potential. When you put all of these characteristics together, you get a stock that has the potential for outsized gains. 

I began coverage on the company back in April when the stock was trading at about $4.50 in an article that can be read at this link.The stock is now trading about 50% higher after reporting two quarters of triple-digit revenue growth. If the company is growing this quickly and the stock is responding with a 50% jump in just four months, this looks like a stock that can reasonably double within a year. 

Takung achieved a strong 400% increase in revenue and an even more impressive 1347% increase in net income in Q2.The company’s Q1 results were also strong with a 197% revenue increase and a 122% increase in net income.This strong growth is driven largely by increases in listing fee revenue from an increase in listed art pieces. Takung is also achieving increases in trading commissions, agent subscription revenue, and management fee revenue.  

Takung’s strong performance demonstrates that the online art trading business model is catching on with artists, dealers, and investors.The beauty of Takung’s business is that the company allows investors to purchase units of artwork, precious gems and jewelry, rather than requiring owning entire pieces.This is like buying art the way investors buy stocks.It allows investors to diversify their portfolios by owning units of art the way investors own shares of companies.You can think of the company as an investment brokerage firm as Takung collects fees and commissions from art traders instead of stock traders.

Image Source: Takungart.com

Takung plans to continue its growth in China.The company is also looking to expand in the following countries: Australia, Mongolia, New Zealand, and Russia.Takung expects to see revenue in the near future from the four new countries as marketing/sales and training resources have been sent there.This increases the chance that Takung will continue its high growth, thus leading to strong stock gains.

Takung is in a great position for continued strong growth as a result of its profitability and positive operating cash flow.At the end of Q2, Takung had $9 million in retained earnings (12% of its market cap of $75.6 million).  Since Takung is highly profitable with a 24% net profit margin according to Q2 results, the company has the cash to fund its expansion. Takung is less likely to dilute shareholders with new share offerings because the company can pay for its expansion with ongoing profits.This is likely to help boost the performance of the stock.

Valuation Remains Attractive

Takung is trading at only 10.8X TTM EPS of $0.63.Most of the other small cap investment brokerage firms are trading with higher valuations.For example, Greenhill and Company (GHL), Piper Jaffray (PJC), and A-Mark Precious Metals (AMRK) are trading with trailing PE ratios of 21, 28, and 11.3 respectively. 

Investment brokerages as a whole (including national and regional) are trading with an average PE of 18.8 according to data from finviz.com.   So, Takung has room for PE expansion along with stock appreciation from the company’s strong growth. 

Risks for the Investment

Since the company is based in Hong Kong, Takung can be perceived as riskier to investors as compared to established U.S.-based companies. If the Chinese economy slows down significantly, it could reduce the demand for expensive artwork and hurt Takung’s business.Therefore, investors might be hesitant to own the company, which could hold back the price appreciation of the stock due to the lack of share demand. 

Takung has a new business concept, allowing investors to purchase units of art, jewelry, and precious gems instead of entire pieces.Although the company is experiencing recent sales success, this is not a proven business model.Takung investors will either have to have an understanding of the value of the listed pieces or trust the company that the listed values are accurate and reflect market prices.    

Conclusion

Although the investment should be considered speculative or much riskier than average, the company is already profitable and is trading at an attractive valuation.Therefore, it is probably less speculative than many small companies on the market that have not yet turned a profit (many biotech companies come to mind). 

Takung is committed to expanding into additional countries, which will allow the company to continue its strong growth. The strong revenue and net income growth rates are likely to catalyze the stock for outsized gains.Stocks have a tendency to increase approximately in-line with earnings growth over the long-term. Since Takung is not well-known, the stock may not grow exactly at that pace. However, even if revenue and earnings only grow at strong double-digit rates going forward during the company’s expansion, it would be reasonable to assume that the stock will significantly outperform the averages.