Chinese Shares Soar - But Can They Be Bought?

The more I look at shares of Chinese companies traded in the U.S., the more I get the feeling that I’m being transported back to 1998. The price appreciation in Chinese stocks over the last two months has simply been unbelievable, with the Shanghai ETF (FXI) up 63 percent since mid-August. But with many of the big cap Chinese stocks beginning to reach very frothy valuations, many investors are left wondering whether they’ve missed the party in Chinese shares.

My answer is a qualified no. I’m certainly not advocating that investors run out and buy anything based in China, but I do believe that we’re still in the middle stages of the move in Chinese shares, and there are still huge gains to be had by selectively trading Chinese shares. Having surveyed the market for Chinese shares, I am wary of the stocks with bigger market caps, as I believe these stocks have all the downside should China fall, but they’ve already moved so far up that the upside is significantly less than some of the lesser known Chinese stocks.

Given the high valuations and high prices of the bigger cap Chinese stocks, investors are beginning to migrate down to small cap Chinese shares, prompting huge breakouts in a number of stocks. A quick look at China Finance Online (JRJC), China Natural Resources (CHNR), China BAK Battery (CBAK), and Advanced Battery Technology (ABAT.OB) reveal the incredible moves we are beginning to see in this space, and my hunch is that these moves are just the beginning of an incredible bull market in shares of small cap Chinese stocks the likes of which we have not seen since the tech bubble. With those kind of gains potentially on the table, some prudent speculation can yield huge overall returns for the portfolio.

As I said earlier, the situation to me looks very similar to the move in tech shares in 1998, and I’m looking back to 1998 for guidance as to where to put money to work at the moment. And given the precedent that was established back in the tech bubble, I think that we have to look at Chinese IPOs as one of areas that could potentially give the biggest gains.

In keeping with my thesis, yesterday afternoon I took a small position in China Digital TV (STV) at $50.32. The company, which makes digital access cards for Chinese TV, has already tripled since coming public at $16 last Friday, but I believe that the stock has a lot more room to run from both a technical and a valuation standpoint. From a technical standpoint, the lack of a pullback yesterday after tripling in 3 days indicates to me that sellers are still holding strong. From a valuation standpoint, the stock is still only trading at about 50 times trailing earnings. While the multiple certainly isn’t that cheap, I don’t view it as expensive for a company whose earnings increased 400 percent year over year. The growth in STV is obviously going to slow, but we are still going to see impressive (and probably triple digit) earnings growth over the next year or two. Therefore, if we assume 100% growth and a PEG of 1, I can pretty easily see this company doubling over the near term.

Obviously, trying to game the valuation here is more art than science, but the bottom line is that STV has very healthy earnings and revenue growth, and it also happens to be at the center of what could turn out to be a huge move higher for smaller cap Chinese shares.

That said, please note that (as with most IPOs) there is significant volatility and risk here, and for that reason, I have intentionally chosen to take a small position in the stock. Investors need to remember to limit risk when trading highly speculative Chinese names, and be sure not to put too many eggs in the same basket. Even small positions will yield big gains for the overall portfolio if Chinese shares continue their recent run, so there is no reason to take on too much risk.

On a final note, I am currently in the process of reading up on several other promising Chinese small caps, so be sure to check back tomorrow for a few more names to research.

Comments

[ChinaMart:]

I agree that staying clear of the parabolas is advised here, and also agree that there are some that excellent value stocks that are still unknown that are taking part in China's torrid growth.

One that a I'll mention here for your consideration is WWMU.OB.

The upside on WWMU: At $6.50, this stock currently trades at a forward PE of 9 based on 2007 eps estimates of .71/share. They have about $1/share cash, no long term debt, and are growing revenues and income at > 50%.

The downside? The float is miniscule with only 308k shares in it, and about 2M shares total outstanding. As a result, trading been extremely thin at this point.

That said, I think it's worthy of a small position here based on their growth, cash/share, lack of debt, and pending acquisition in November that will be immediately accretive to earnings.

2007 Oct 11 06:21 AM

[ehp246:]

Shanghai ETF FXI? And you are giving stock advice?

2007 Oct 11 08:43 AM

[The Mirror ...:]

Do you know anything about the internal working of the Chinese economy? Do you know to what extent the government can manipulate (the appearance of)it at will? State-owned enterprises have no accounting accountability, are administrative monopolies, and can cook their books, move money around between group companies, get no-interest bank loans - and in a one-party state do you think you'll have sound financial analysis or reporting?Even institutional American investors won't know what the hell they are getting into.

Take it from me - I am a diplomat who was stationed there. This show can only go on for so long. You know you are in a bubble when unscrupulous ads on the Christian Science Monitor site is marketing to unsuspecting John and Sally Does in this benighted naive country. DON'T GO THERE!

2007 Oct 12 02:00 PM

[Tony1:]

Very informative article. Keep covering the Chinese stocks and upcoming IPO's. Thank you very much

Tony A

2007 Oct 13 01:58 PM

[bert:]

Now that all you guys got destroyed on STV maybe I'll pick some up at 28.00! Actually I had considered to enter before luckily i forgot!

2007 Dec 23 12:22 PM