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3 Chinese Stocks to Sell

Chinese stocks haven't done well in 2013

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Vipshop185newThe Gilt Groupe is an e-commerce business that runs 200 flash-sales per week featuring top brands like Jimmy Choo. Only six years old, it already has 7 million customers. Vipshop Holdings (VIPS) is trying to replicate that same success in China with mixed results so far. However, its stock certainly has taken flight, up 353% since its IPO in March 2012 and 65% in 2013. VIPS was the best-performing IPO out of 128 issues in 2012, up 154% — definitely a momentum stock.

Everything about its Q1 report is spectacular: Net revenues grew 207%, gross margin increased by 220 basis points to 23.4%, and net income went from a loss of $8.6 million in Q1 2012 to a profit of $5.8 million in Q1 2013. And Vipshop’s revenue guidance for Q2 was 144% growth year-over-year. There’s not much you can say about its numbers except that it didn’t forecast earnings for the second quarter, which leads me to believe management is having a hard time nailing down expenses. It could just be that VIPS is growing so fast it can’t keep up with its financial modeling … or maybe something more sinister is afoot.

Having invested small amounts in two fraudulent public companies (one in China) over the years, I’m acutely aware of the risks involved in betting on fast growing businesses operated in less-regulated parts of the world. Barron’s ran an article in April that questions the authenticity of some of the products sold in Vipshop’s flash sales. The most flagrant example was Coach (COH) bags sold on its site for $234 to $429.

The problem isn’t that the bags were counterfeit, but that they were sold without Coach’s permission. That raises the question: How did VIPS gain possession of the product in the first place? Whatever the true story is, short sellers began to circle the wagon, forcing VIPS to release a statement addressing allegations of impropriety. One of the shorts is none other than Carson Block, the man who brought down Sino-Forest for its fraudulent actions. Although Block doesn’t regard Vipshop as a fraud, he does believe its business model is badly flawed in the long term.

I personally doubted Herb Greenberg back in 2001 when he was highly skeptical of ACLN, a Belgian-based company (my other loss due to fraud) that shipped cars to Africa. As it turned out, the books were cooked and the stock tanked faster than the Titanic. Now I’m not saying any of the shenanigans that went on back then are happening in this situation, but when a stock rises so quickly and allegations arise, one needs to step back and have an objective re-examination of the facts.

Any future signs of trouble, and VIPS stock will be back in single digits or lower.

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