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Chinese stocks have been out of favor these days among investors, and for a good reason: China's market has been among the worst performers in the last 12 months, especially once-popular Chinese Internet stocks. Baidu (NASDAQ:BIDU), for instance, is down 18%, Sina (NASDAQ:SINA) is nearly flat, and Renren (NYSE:RENN) is down 40%. iShares FTSE China (NYSEARCA:FXI) is almost flat over the same period, compared to a 20% gain for the SPDR S&P 500 Trust ETF (NYSEARCA:SPY).

Company/Index

3 Months

12 Months

Baidu

+9%

-18%

Sina

+10

+0.20

Renren

-5

-40

iShares FTSE China

-14

0.10

+3

20

Investors have been concerned about the state and the direction of the Chinese economy -- most notably, China's looming debt crisis, as described graphically in a cover story in this weekend's Barron's. "Chinese companies and local governments have borrowed recklessly to build factories, train stations, and bridges to nowhere," writes Jonathan R. Laing. "Miles upon miles of empty apartment buildings rim hundreds of Chinese cities; industries suffer from rampant overcapacity; and largely empty new highways, bridges, shopping malls, railroad stations, and airports more than hint at problems."

Chinese Internet companies had their own specific problems. Most notably, the majority of these companies suffer from a lack of profitability. Some had problems with regulators both in China and the U.S. that scared the momentum investment crowd away. But after such a prolonged decline, the time may be ripe to get into Chinese stocks, especially after the Alibaba-Sina $586 million deal last month that may be a game-changer for these stocks, as it confirms that there is plenty of value in the sector.

Be selective. Buy companies with sound financials like Baidu and Sohu (NASDAQ:SOHU), in addition to Sina. But steer clear of companies with shaky financials like E-Commerce China Dangdang (NYSE:DANG), Renren, and Youku (NYSE:YOKU). (See the two tables below comparing the financials of all six companies for April 2013 and August 2011.)

Here is a list of the most active Chinese web companies in late May 2013:

Company*

Business

Forward P/E (December 2014)

Operating Margins

Baidu

Internet search engine

14.71

46.52 (%)

Sina

Media and mobile value-added services

29.19

22.30

E-Commerce China Dangdang

Business -to-Consumer e-Commerce

--

-9.42

Renren

Social Networking

--

-52.09

Youku

Internet TV

21.62

-25.02

Sohu.com

Brand advertising, on-line gaming

18.13

23.15

*These statistics should be interpreted with caution, as Chinese accounting standards are different from those of the U.S. They aren't comparable with those of their U.S. counterparts like Amazon.com (NASDAQ:AMZN) and Google (NASDAQ:GOOG).

Source: Yahoo Finance.

Here is a list of the most active Chinese web companies in early August 2011:

Company

Business

Forward P/E (December 2012)

Operating Margins

Baidu

Internet search engine

30.88

52.18 (%)

Sina

Media and mobile value-added services

51.54

22.30

E-Commerce China Dangdang

Business -to-Consumer e-Commerce

121.57

0.32

Renren

Social Networking

187.50

5.42

Youku

Internet TV

1,312

-20.41

Sohu.com

Brand advertising, on-line gaming

13.29

37.50

Source: Yahoo Finance.

The bottom line: A prolonged decline in Chinese stocks and a wave of corporate deals may create buying opportunities, but investors must discover it the old way. Hype should never be a substitute for due diligence.

Disclosure: I am long GOOG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.