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By Maj Soueidan

It finally happened. The ChinaHybrid universe reached valuation levels that were able to convince investors to take a chance on a sector that has been priced to fail or as some say properly placed if companies are much smaller then they claim to be. Whatever the case, many investors are banking that it can't get much worse.

If you feel comfortable using SEC filings as a guide, from a pure valuation stance ChinaHybrids are cheaper than they have ever been, even after the recent rise. One by one, deeply discounted stocks are beginning to make moves from their bottoms, ignoring bad news and pricing P/Es away from failure.

I will participate in this rally for as long as it lasts. Some of the direct strategies I have been employing include:

  • Day trading "hot" IPOs on the day of the offering such as Chinacache Intl Adr (NASDAQ:CCIH), Mecox Lane Limited (NASDAQ:MCOX) and Tal Education (NYSE:XRS).
  • Establishing short-term positions in IPOs that have underperformed such as Tianli Agritech (NASDAQ:OINK) and Daqo New Energy Corp (NYSE:DQ)
  • Look for underperforming stocks in outperforming sectors. We were looking at China Wind Systems Inc (CWS), but a shelf filing has made us tepid.
  • Identifying new companies that have not been found by wall street. I am looking at China Electronics (OTCQB:CEHD) Huifeng Bio-Pharma Tech (OTC:HFGB) and Eastern Environment Sols (OTCPK:EESC).
  • Keeping tabs on new reverse mergers, especially when EPS targets are present as part of the deal. Sino Oriental (SMPN.OB).
  • Identifying companies that are addressing corporate governance concerns, such as Renhuang Pharmaceuticals (NYSEMKT:CBP). The hope is that these stocks will experience P/E expansion once issues are resolved.
  • Tracking firms that have received debt financing, based on the assumption that banks will perform extensive due diligence before loan approval. Telestone Technologies (NASDAQ:TSTC).
  • Taking a look at fallen angle IPOs of the past that are attempting to reestablish an identity. Lj Intl (NASDAQ:JADE), Cdc Corp Cl A (NASDAQ:CHINA), China Techfaith Wireless Adr (NASDAQ:CNTF).
  • Look for stocks where short interest is high.
  • Considering companies with attractive valuations compared to EPS growth, especially if they have been shareholder friendly such as China Mediaexpress Holdin (OTCPK:CCME) and Deer Consumer Products (OTC:DEER):
    • Have approved stock buy programs
    • Considering stocks where insider buying/institutional buying is significant
    • Considering stocks where EPS guidance exists see

Tier one stocks, CCME and DEER, have made impressive moves from this last category. Tier one stock New Energy Systems (OTC:NEWN), has yet to stage a significant rally.

Riskier investors may want to devote a small portion of funds across a diversified list of names that have come under serious fire, especially if you choose to embrace SEC documents. This is where some of the biggest moves could occur, but it is risky. (I have not actively explored this plan, but call options may be a nice way to approach this strategy.)

  • China-Biotics (OTCQB:CHBT) - What happened to my retail operation.
  • Duoyuan Printing (NYSE:DYP)- Won't show the Quan.
  • China Sky One Medical (OTCPK:CSKI)- PRC Govt. getting involved; Loses customers.
  • Fuqi Intl (OTCPK:FUQI) - Aggressive accounting practices; Being investigated by the SEC.
  • China Green Agriculture (NYSE:CGA)- Won't disclose seller of recent acquisition.
  • China Yida Holdings (NASDAQ:CNYD) - Wants to become Sarbanes-Oxley compliant.
  • Tongxin Intl Ltd Com (OTCPK:TXIC)- Where did the money go?
  • Wonder Auto Tech (OTCPK:WATG)- The shorts just found this one.
  • Orient Paper Inc (NYSEMKT:ONP) - What is taking so long? Results of an investigation by the Audit Committee are around the corner.

On the same front, we will not fall in love with stocks in what should be an emotionless game. There is still risk in this space. Companies like CEHD still retain under loved auditors such as Kabani; this baffles me. You have basically begun digging your own grave. EESC must amend its past financial filings. In any event, the key to play this space is to find a way to participate in the universe without having its potential dissemination destroy portfolio returns.

Rules I am following to limit risk:

  1. Limiting my ChinaHybrid portfolio exposure to no more than 25% to 30%. I was easily close to 90% China in 2009, which certainly paid off. But I currently see ample opportunities in the U.S. market that I believe will help me achieve returns similar to if I was 100% in China. Since November 2009, I have mentioned my intent to reduce China portfolio exposure on numerous occasions.
  2. Limit risk by cycling into cheap stocks that have not yet moved, while lightening up on ones that have made aggressive moves. The more aggressive the move, the more likely that shorts will climb aboard.
  3. My positions in individual Chinese names are not as large as in the past.
  4. Establish a strict discipline on a portion of my holdings, such as selling when a stock has increased 20.0% from my entry point. Do this three and half times and you have doubled your money.

As quality is restored to the space, I will consider adding ChinaHybrid exposure to my portfolio. If you are a gun slinging cowboy, as I normally am, then a big bet on ChinaHybrids now could make you the talk of town, but recent events have humbled my ego.

To help investors with their due diligence, I have included a few screens with personalized thoughts.

-Stock Buy Back
-Companies with EPS guidance
-China stocks on our radar

Please see related article

Disclosure: Author long OINK, CWS, EESC, CBP, DEER, NEWN, HFGB, ONP calls

Source: How to Profit From the Resurgence of ChinaHybrid Stocks