Jim Trippon's  Instablog

The stock that blew away the competition in a dismal market last week was China Automotive Systems (CAAS). Shares of CAAS have been in a sickening slide since the beginning of the year. That was when Beijing removed the last subsidies on new car purchases.

Surprisingly, it wasn't an earnings report that moved CAAS shares this time. It was a flurry of media reports that China was considering revising or removing license plate quota regulations. Those quotas have contributed to slumping car sales and they've loomed large over sagging automotive stocks.

Because of severe traffic congestion, the city of Beijing imposed a quota last year on the number of license plates handed out each month. Beijing now offers only 20,000 new license plates each month, and awards them out through a lottery.

Beijing's draconian quota has dented car sales in the capital severely. It has also generated rumors that more license plate quotas would be imposed in other congested cities like Shenzhen and Guangzhou. This fear of a spreading government crackdown on car ownership has created a major drag on automotive shares.

CAAS is a good case in point. The company beat expectations with its earnings report in April but shares couldn't sustain their gains.

The auto parts maker reported that for the quarter ending December 31, revenues grew 20% to $100.5 million, exceeding analyst estimates of roughly $90 million. For all of 2010, the company's sales rose 35.3% to $345.9 million. The company said at the time that it expects revenues to grow 20% in 2011.

With numbers like that CAAS appears to be a stock that's ready to pop. It has a forward P/E multiple of only 7.00 and a PEG which registers at a dirt cheap 0.42.

There are a lot of positives about China Automotive Systems and the stock seems to get cheaper and cheaper as earnings rise. But I wouldn't bet on it just yet.

The Chinese reports of an end to the license lottery system haven't been confirmed. A retraction would be a severe setback.

The other factor weighing down on Chinese automotive stocks is an industry-wide slump in sales. China's auto sales sagged in May for the second straight month, losing 8.7 percent from the year before. For the year to date, sales of passenger cars gained only 6 percent, far short of the 55 percent jump during the same period last year.

Two more reasons are cited for weak auto sales in China: oil prices which were still rising in May, and supply disruptions caused by the Japanese earthquake.

China is still the world's largest automobile market with sales topping 18 million units last year. What's more, growing the industry is important to Beijing's goal of enhancing domestic consumption and spurring innovation. Government action to revive the industry seems inevitable.

Currently there aren't many Chinese auto companies available to western investors. CAAS appears to be the best buy. But caution is key in today's ugly market environment.

CAAS wasn't able to sustain its gains after a good earnings report. So there's little reason now to hope for a surge in the stock despite good valuation and many analyst "buy" recommendations.

The potential is there. But China's auto industry needs to see a major turnaround before I buy into the CAAS share price jump as a trend rather than a short-term diversion.