Hot China Stocks: A Bubble to Avoid

The last few weeks may have signaled a possible top looming in Chinese ADRs and our zealous impulse to own them. I believe this because of the recent emergence of China related stocks that are the product of reverse mergers.

BARRON'S also mentions these companies this week and the astonishing fact that they are up a combined 25% since Sept. 18. These stocks are coming in droves onto the Nasdaq and AMEX and with plenty of high flying moves, enough volatility to lure even the most disciplined investor into nibbling just for a chance at a quick 100% daily gain.

Sporting trendy names such as China Architectural Engineering (RCH) and AgFeed (FEED)and having businesses focused in hot market sectors such as fertilizer, chemicals, infrastructure and technology, these stocks may be trading more on hype than earnings. I spoke with one of the firms offering investor relations for one of these companies and he said that most companies in this particular space should not be trading at more than 5 to seven times its earnings, yet the firm was already sporting a PE of 24.

Some names that have been extremely hot, other than those already mentioned, are China Battery (CBAK), Shengdatech (SDTH), China Automotive Systems (CAAS) and China Finance Online (JRJC). Coupled with their rise to stratospheric levels has been explosions in volume as well. This becomes a giant red flag as most of these reverse merger companies reported insiders can sell shares immediately upon being listed. You really need to wonder who is buying and who is selling.So why not short sell these momentum plays. That also poses a problem because most of these securities have been volatile and the spreads they offer are broad --- some sporting nearly 50 cent differentials between the bid and ask at different points during the market day.Alas, what's a trader or investor to do? For me, I will remain on the sidelines while these Chinese offerings play out and wait for the investor class action lawsuits to follow their crash to earth.

Disclosure: none

Comments

[bd1990:]

The similar behavior of these few stocks you mentioned has quite different stories behind the rally. A look into SDTH's P/E of teens and JRJC's P/E of over 100 tells a lot. We should also avoid avoiding the Chinese ADR categorically.

2007 Oct 07 03:17 PM

[iddjjs:]

Even the behavior of SDTH and JRJC are totally different. In the past month, JRJC went up from roughly $10 to $40, while SDTH was from $5 to $7. How could the author put these two stocks in the same group?

2007 Oct 09 05:13 AM

[Richie:]

Most of the stocks you mention should not be referred to as Chinese stocks as they are not listed on any Chinese exchange. They are really US companies doing business in China but listed (mainly) on our BB or on our NASDAQ market(s).

2007 Oct 09 02:59 PM

[microman:]

A few comments on this short-sighted and poorly-researched article. First, the stocks listed have China operations, but are not necessarily ADRs/ADSs. Second, I trade these stocks regularly, and other than FEED, rarely see a spread more than a dime, let alone fifty cents. Third, the five stocks mentioned by the author are NOT created equally. Each needs to be analyzed separately. Fourth, one of the MANY attractive features of these stocks is the superiority of the growth rate compared to American stocks in the same or similar sectors. PE's "for a particular space" is too generic; such analysis needs to take into consideration growth rate, not just what sector a company is in. In fact, when considering the macro case for companies doing business in China, I would argue the point that DESPITE the recent runs on these stocks, only now are they starting to catch up to where they should be valued based on their powerful fundamentals. One caveat: It's probably a better approach to TRADE the US-listed China sector than to fall in love. I like the strategy of getting in them early (e.g. nobody has picked up on HQS yet), let them double, sell half, and let the rest ride for free.

2007 Oct 10 08:40 PM

[JInks:]

To include SDTH in this so called danger stocks list is dumb...this company has no debt, just completed a new plant to triple production ,had excellent earnings last qtr,insiders hold 43% of the shares and has hardly moved in the last 45 days or so in terms of stock price.The runup yesterday is undoubtedly in anticipation of an excellent Qtr .

2007 Oct 11 05:53 AM

[JInks:]

To include SDTH in this so called danger stocks list is dumb...this company has no debt, just completed a new plant to triple production ,had excellent earnings last qtr,insiders hold 43% of the shares and has hardly moved in the last 45 days or so in terms of stock price.The runup yesterday is undoubtedly in anticipation of an excellent Qtr .

2007 Oct 11 05:53 AM

[HH99:]

Misleading. Study about China first if you want to comment on Chinese stocks. Here is an example of a good analyst.
seekingalpha.com/artic...

2007 Oct 11 07:21 AM

[staylor:]

How can you include SDTH in these stocks? This author is speculating through use of skullduggery and voodoo. SDTH financials are superior to most stocks found on any market. Sad to see this kind of sabotage after the stock just broke out. I wish I had bought it.

2007 Oct 16 04:17 PM

[liberated:]

Well, Chinese stocks may be up much, but there is no bubble so far. To reach a real bubble, PE needs to be over 100 or even 1,000 like Japanese stocks have done about 20 years ago, and everything must be rosy.

I remembered that Japan stock market average P/E is 1,000 around early 1990s, and at the same time Japanese were still arguing there was no bubble as Japanese real estate was expensive enough to justify the high P/E ratio. I was in Japan during the time, all the Japanese I encountered told me so. That is the time for real bubble.
Because a stock went up 120% in a year did not justify a bubble. With so many negative comments coming out, a real bubble is far away.

During the real bubble time, US high tech stock has P/S over 100 and without any meaningful P/E. That is the real bubble time.

2007 Oct 17 06:04 PM