But These Stocks are the Real Traps
Long-term readers know that I am bullish on China stocks and Asia at large, but there have been numerous reports of late of Chinese companies being embroiled in accounting scandals and questionable practices. For example, China stock Rino International (OTC: RINO) recently admitted to falsifying its numbers and was delisted from the Nasdaq. Unfortunately, this type of scandal has tainted the whole sector, preventing some investors from taking part in the Chinese wealth machine.
Clearly, the lack of credibility in RTO Chinese companies is now a big problem for China stock investors. Each time a previously unknown small research shop, blogger or short-seller raises questions, many of these small-cap reverse-merger stocks drop dramatically before the claims can be examined at depth by investors. As a result, many investors are selling first and asking questions later — if at all. The template seems to be a short-seller will short a small Chinese stock, release a negative report on the stock — pushing it out on a personal website and spreading it through online financial message boards and communities — then cover after the stock drops
So it is more important than ever before to have a China guide to make sure that you avoid these China stock traps — and on the following pages are a few stocks that I think have more downside than upside.
China Stock to Sell #1 – Youku.com (YOKU)
I have mentioned before to stay away from Youku.com (NASDAQ: YOKU), which is an interesting Internet company marketed as the “YouTube of China.” However, just because Google (NASDAQ: GOOG) bought YouTube, I doubt that the “Google of China,” Baidu.com (NASDAQ: BIDU), will step in and buy Youku. And the volatility here has been extreme — Youku was the biggest first-day gainer of 2009, posting a massive 161% rise from its $12.80 IPO pricing to the $33.44 close. Since then, the stock has continued to trade in a big range.
Looking at the fundamentals, there was a negative 12% net income margin last year, which is normal for fast-growing companies that heavily invest in their business. Some investors believe that China’s highly fragmented video market will be consolidated by Youku.com, but more visibility is needed before making this judgement. The company is set to release earnings on Feb. 28, and I certainly wouldn’t recommend making a move into shares until then.
I think that in the present environment of heightened geopolitical instability it will be very difficult to make money with stocks with an expensive price-to-sales valuation, such as Youku’s 77 ratio, with no earnings. The stock could be cut in half and still be expensive, so I would stay away for now.
China Stock to Sell #2 – Feihe International (ADY)
Feihe International (NYSE: ADY) has fallen more than 75% from its 2009 highs and is likely to continue falling. The company missed earnings and has made an impossible deal with Sequoia Capital. If the company’s earnings were good — based on preset targets — it has to issue an additional 520,000 shares to Sequoia. However, if the share price is less than $39 per share, ADY needed to buy back shares issued to Sequoia for a price 130% higher than the original price.
In early February, Feihe agreed to purchase the 2,625,000 shares that Sequoia Capital acquired from the company pursuant to its August 2009 financing. The repurchases are scheduled to happen in four installments over the next year. This is huge overhang of stock, which arguably will not hit the market immediately but will cost the company dearly.
Sequoia Capital originally agreed to give Feihe financing in August 2009. The agreement granted Sequoia Capital a right to have these shares redeemed under certain conditions, which now have been met. Chalk this one up to a case of buyer’s remorse and a still-valid generous return policy. Stay away from ADY.
China Stock to Sell #3 – China Executive Education (CECX)
China Executive Education (OTC: CECX) markets training and educational services to the successful and up-and-coming professionals who want to advance to new levels. It strives to provide education that most U.S. business schools don’t offer that is beyond their traditional classroom topics.
While this is an interesting niche industry, the company’s CEO is not inspiring confidence. And considering how poorly written the CEO’s book was, it is hard to believe he can teach. This stock has been touted recently, and I’m afraid that investors will jump the gun and get burned, especially if the stock is up-listed from trading OTC to the Nasdaq.
Looking at the price action, clearly CECX has been seeing some big upward movement — the stock has more than doubled since the middle of last year. Nonetheless, this is a company that I don’t want to own long-term.
China Stock to Sell #4 – China Industrial Waste (CIWT)
China Industrial Waste (OTC: CIWT) provides a “one-stop” comprehensive solution of industrial and commercial waste treatment. CIWT charges service fees and also makes money from selling scrap materials and recycled products. However, the company’s CEO is too cheap to hire the professionals required to properly handle a U.S. public listing and the stock has suffered for it.
There are many promising companies that are listed OTC in the United States, but without proper accounting conversion to GAAP methods, which many Chinese companies do not want to do, the shares may stay depressed for many years and investors will wonder why the operational performance is not reflected in the share price. There needs to be a credible auditor and proper listing for serious investors to be interested.
China Stock to Sell #5 – E-Commerce China Dangdang (DANG)
E-Commerce China Dangdang (NYSE: DANG) is the country’s largest online book retailer, yet the shares are under significant pressure, and I think they may go lower in the present environment. People look at Amazon.com (NASDAQ: AMZN) now and are impressed with the company’s surging sales and earnings, but many forget that the company bled red ink for years after it went public while shares suffered. Dangdang is in a similar situation. Shares have been volatile since its IPO late last year.
Although Dang is making a little bit of money, the P/E is meaningless at close to 1,000. As the “Amazon of China,” Dang is supposed to aggressively expand more into selling general merchandise — and as it expands its distribution network, its current small profit can quickly turn into a big loss. Without solid growth in sales and profits, I would rather avoid this stock for now and continue to watch it for an opportunity later.