Afraid of Chinese OTC Stocks? Two You Might Like

 |  Includes: CKGT, LTUS
by: Dutch Trader

Normal Chinese stocks listed on Hang Sang or ADRs listed in NY not high growth enough for you? Chinese ETFs nothing for you? Well, there is a bunch of overlooked Chinese stocks that could be a significantly better buy than the state-owned enterprises and big companies picked up by analysts just looking to add a bit of China to their portfolios.

There are a growing number of Chinese companies that sell shares only on the smaller, OTC Bulletin Board (OTCBB). Stocks quoted on the OTCBB must comply with U.S. Securities and Exchange Commission (SEC) reporting requirements. These stocks can prove to be very profitable for those willing to put the time into watching over their investments and keep up their research.

Though Chinese OTC stocks have a higher risk because of little oversight. These stocks stand out in a few ways. First, lack of publicity means many of these stocks are Undervalued, Underowned and Unloved. Second, China's small-and medium-sized enterprises grow much faster than the larger state-owned companies, which are most easily accessed by foreign investors; they are also much less prone to regulatory shocks. Third, many of these stocks are in sectors which are almost inaccessible any other way.

A lot of Chinese OTC-stocks have relatively good balance sheets with almost no debt. The majority has a good a profit margin and of course makes profit. In most cases you're looking at a relatively risk-free investment.

Take a company like China Kangtai Cactus Bio-Tech (OTC:CKGT). The company is a leading grower, developer, producer and marketer of cactus-derived products. Cactus had been used since ancient times as both a food and as medicine for its health benefits. The fact that no net income guidance was provided and that no color on margins was provided in the press release will keep investors in limbo regarding EPS. Geo Investing's low end EPS estimate from their April 20, 2010 research note yields the following:

  • 1st Qtr. 2010 EPS $ 0.04 Reported
  • 2nd Qtr. 2010E $ 0.10
  • 3rd Qtr. 2010E $ 0.17
  • 4th Qtr. 2010E $ 0.20
  • 2010 Full Year Estimate $ 0.51

The EPS calculation assumes that non-GAAP net margins will come in around 30%. Of course, if first quarter margins do not improve, EPS could come in lower, unless revenue growth is more robust than company expectations.

Today's valuation makes it despite some issues attractive. Shares are trading around their book value per share and have only an adjusted P/E below 4.

There are also a number of smaller pharmaceutical companies listed on the OTCBB which could either be bought together to lower the risk profile or bought selectively with a bit of pre-research. Lotus Pharmaceuticals (OTCPK:LTUS) is especially recommended by China OTC-followers. The company is a growing developer and producer of drugs and a licensed national seller of pharmaceutical items in China. The shares are traded at $ 1.04 well below book value of $ 1.44, with an EPS estimate of $ 0.45 this stock has only a P/E of almost three.

Of course there are always risks with investing in Chinese OTC stocks, but you have that also with stocks on a major exchange. There are always companies that won't survive. Fraud, dilution issues and losses can drive stocks down that is why a margin of safety is important when you want to be a value investor.

Chinese small-caps give you a great opportunity to benefit from the growth stories and extraordinary profits that can be made.

Disclosure: Author holds long positions in OTC:CKGT and OTCPK:LTUS