Exploring Cheap Chinese Stocks

• ByTim Melvin, RealMoney.com Contributor
• On 2:00 pm EDT, Friday October 9, 2009

When I got back from all my meetings and errands yesterday, I was happy to see my latest copy of The Astute Investor in the mailbox. The publication is basically a statistical service, which I find very useful in my ongoing search for cheap stocks. There is very little commentary, just a list of profitable stocks below book value and below net current asset value. Last year and into the spring, the mailing was a thick bulky envelope with 10 pages or more of qualifying stocks. This month's edition is just two pages front and back. Clearly the rising market has eliminated most of the cheap stock opportunities.

I also noticed that the lists are very slanted toward micro-cap stocks. I have said before that I think the real opportunity for deep value investors right now lies in this segment of the market. These stocks are not as influenced by the short-term trading activity I see occurring in the larger stocks right now. They tend also to have higher insider ownership than their larger brethren.

Many of the shipping companies make the book-value-with-earnings-power list. International Shipholding and Overseas Shipholding are both on it. I mention this for the benefit of readers who have a much greater understanding of shipping stocks than I do. I have never been able to get a handle on or make a dime with these stocks over the years.

Some of my old favorites are still on the list. Actions Semiconductor is on there because it still sells for less than cash on the books. The semiconductor company is the first Chinese stocks I have purchased, but it will not be the last. The extreme volatility of the Chinese markets has pushed several stocks down below net current asset value, and I am continuing to explore that region. They are continuing to grow on the world economic stage, and I do not see that ending for decades.

In fact, there were some Chinese companies that caught my eye in this edition. Qiao Xing Mobile, as its name would suggest, is in the cell phone business. The company sells through distributors as well as directly to the consumer via television, the Internet and six stores throughout China. Qiao Xing has seen a slowdown in revenue and profit because the economy has caused a general decline in activity, but the stocks is incredibly cheap, selling for less than 60% of the net cash on the balance sheet. You get the business for free. The company said recently that it was cautiously optimistic that business would improve as economic conditions recovered over the next few quarters. Shan Capital, a U.S.-based firm with activist tendencies, has accumulated 7% of the company

China Tec Faith Wireless is also in the handset business, as well as the wireless software and applications business. It is not quite as cheap as Qiao Xing, selling for a little bit more than net cash. But when you add in inventories and other current assets, the stock sells at a discount to net current asset value, so it qualifies as a Graham-style bargain. In a recent conference call, management said it expected stronger growth as a result of the Chinese 3G market and what it called a recovery already under way in the global cell phone handset market.

The company also has exposure to the Chinese online gaming market, a market with tremendous potential as the country continues to grow a middle class. It is releasing three massively multiplayer online role-playing games this year and also 16 games available for mobile downloads.

I do not hold myself out as an expert on Chinese stocks by any means. I like the fact that these two are listed here in the U.S. and that Qiao Xing trades on the NYSE. The accounting seems straightforward. There is some long-term political risk in holding China stocks, but I think that the country will continue to grow as an economic and political presence, and those risks will lessen over time. I do know that these two stocks are cheap on the numbers and an excellent way to gain exposure to the growing consumer middle class in China. I may buy a bit less than I otherwise would because I'm still learning the ins and outs of investing in China, but I am going to buy a little in the days ahead.

On balance, this month's edition of the statistical service confirms that bargains are scarce. This is usually a precursor to the stock market topping out in the weeks ahead. I am not a market timer, but stocks are no longer cheap, and caution should prevail.

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Please note that due to factors including low market capitalization and/or insufficient public float, we consider Actions Semiconductor, International Shipholding, Qiao Xing Mobile and China TechFaith to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Buzz up!