Wishful Thinking: Navigating the Chinese Small-Cap Sector
Most people know that there have been a lot of problems recently among Chinese reverse-merger companies. I don't want to turn this blog into a debate about the honestly of these companies, but I think everyone can agree that there is a lot of risk surrounding this entire sector.
Still, China is a fast-growing economy and I don't want to avoid it completely. I want to invest in Chinese small-caps while still limiting my risk.
I did this by playing around with the screener at the China Tracker website, to find companies that met several different criteria:
1. Must have gone public through an IPO (not a reverse-merger).
The IPO process requires a comprehensive audit of the company, and I don't know of any Chinese IPO companies that have been accused of fraud. Therefore, this criteria removes a lot of risk from the equation.
2. Must have a top-4 or top-10 auditor.
I only included companies where the auditor had already signed off on an annual report, or in the case of newer companies, had audited them during the IPO process.
3. Good financials.
I didn't have specific criteria here, but I looked mainly at PE, revenue growth, and earnings growth. I only included companies that had "good" financials.
4. Low short interest.
This is another way of limiting our risk. Short interest could be an indicator of fraud or other problems.
5. Not related to the construction industry.
I believe China is in a housing bubble right now, so I don't want anything to do with construction. I used the Forbes housing price indicator to come to this conclusion.
After looking at all these criteria I came up with 3 Chinese small-caps that stand out from the rest:
CNTF - They sell gaming systems, cell phones, and other high-tech gadgets. Based on their annual report, their products actually look pretty impressive. Most of their sales are in China but they are also starting to sell them in Brazil. Their CEO recently purchased a lot of shares.
MY - A wind energy company. They sell gearboxes to wind turbine manufacturers all around the world. They have also started selling products for the high-speed rail industry.
CHRM - A Chinese media/advertising company. Along with CNTF, this is a good play if you think the Chinese middle class will continue to grow.
Disclosure: long CNTF and MY.