Cheap Chinese shares update

So far, not so good..

We set out a number of reasons and criteria for selecting cheap Chinese shares in this article. In summary we:

  • Argued that the Chinese environment offeres superior growth opportunities.
  • We were selecting stocks with an American listing that were cheap, had good growth records and opportunities, good balance sheets (often almost entirely debt-free) and we thought they’d offer superior risk-reward situations.
  • The timing of the series was deliberate as smallcap stocks often have their best month in January (if anything, we got rather behind the curve doing the write-ups).

Well, what seemed a good idea at the time (only two weeks back or so) doesn’t turn out to be so good. Let’s revisit some of the fundamentals:

  • The Chinese economy does indeed offer superior growth opportunities! It’s already in double digits again..
  • But that has the Chinese authorities scared. They are trying to cool off credit creation especially. This has the markets spooked.
  • Unfortunately, since the mainland markets are off-limits for most foreign investors, this angst has let to a bit of a bloodbath in our targeted sector, cheap, small Chinese ADR’s listed in the US.
  • Many of these stocks are already very cheap, and have become quite a bit cheaper last week.

A natural reaction would be to ask whether that would make them even better buys. The answer to that will not reassure everybody:

  • We have little doubt that at $18 for FUQI, or $13 for CFSG, or $15 for CGA (to name just a few), you’ll get terrific bargains for the longer-term. The metrics are just too good, unless you believe that China will crash
  • However, we have seen earlier in 2009 that already very cheap metrics can be beaten to pulp in bad market circumstances. In March 2009, for instance, FUQI sold at a low of $3.39. Now, arguably, the circumstances of March 2009 are one in a generation (or even less), but that offers little guarantees that a continuing bad market might very well further erode these stock prices.

Is there any relief in sight? Well..

  • The Chinese indexes are at half their level of their peak in 2007. There is no real sign that they are terribly overvalued.
  • However, monetary tightening will at the minimum contain them, and Chinese shares happen to be very volatile (although with the new trading rules offering margin and shorting, that volatility might become less)
  • Our smallcap Chinese ADR’s listed in the US that function for many as a proxy to the Chinese market will just have to suffer these gyrations, almost irrespective of how cheap they become
  • But, there is one thing that could provide some floor, and that is earnings. If these shares manage good earnings (and considering what’s going on in the Chinese economy there is every reason to expect that), this will confirm their growth story and will give more people a level of confidence buying in.

So we’ll continue with our coverage, but exert caution for those that expect immediate gains.