Why I Broke Up With Chinese Stocks

Zacks

I used to love Chinese stocks. Four years ago, I owned several in my personal portfolio. Investing in China seemed like a no-brainer.

We could buy a piece of a country that was emerging into the largest economy in the world. It was like being transported back to the United States in the 1880s or Japan in the 1950s, just as those two countries were breaking out into global super stars.

As more Chinese companies listed on the U.S. exchanges, it provided an even easier way to invest in the Chinese growth story. I was no longer limited to ETFs or mutual funds. I could invest in individual stocks themselves.

Even the Great Recession didn't turn me off to Chinese stocks. After a huge government stimulus kicked in, China's economy came roaring back. Once again, it seemed like a great time to get into China's future restaurant chains, oil explorers, and industrial companies.

Reverse Merger Nightmare

Then came the problems with the reverse merger companies. These were smaller cap companies that used the reverse merger structure to take themselves IPO. Scandals and allegations of fraud erupted with several of these companies putting a taint on the entire group of small cap Chinese stocks.

Research firms specializing in shorting became famous for issuing a negative report on a small cap Chinese company only to see the stock plunge 30% to 40%. No one, it appeared, was safe.

Then questions started about their accounting techniques. Despite some Chinese companies using western auditing companies, video of abandoned shipping docks at Chinese manufacturing plants, which should have been teaming with employees and shipments, started appearing on the Internet to discredit some companies.

Fleeing U.S. Exchanges

To avoid the embarrassment of overzealous American investors and research firms, several Chinese companies have simply decided to exit the U.S. equity markets. According to a recent article in Bloomberg Businessweek, the China Development Bank is spending $1 billion to buy back shares of several small Chinese companies currently listed on the U.S. exchanges so they no longer have to deal with the messiness of being listed.

These companies include Fushi Copperweld (:FSIN) and China TransInfo Technology Corporation (:CTFO), both which are Zacks #3 Rank (Hold) stocks, and have market caps under $500 million.

There's Always Risk

There are always risks in investing. Risk is not limited simply to Chinese stocks. American companies have had accounting scandals and disgraced CEOS just the same.

But there appears to be less transparency in Chinese companies. This lack of information, combined with aggressive short selling research firms, has proven to be a devastating combination.

What About The Big Cap Chinese Stocks?

Whenever I tell someone that I've broken up with all my Chinese stocks I inevitably get asked, 'Even the big cap ones?'

By 'big cap' they mean companies like Baidu, PetroChina and China Mobile. More analysts cover these companies than the small caps and two out of the three actually pay sizable dividends.

Many investors consider dividend paying companies to be golden because it's hard to 'fake' the actual cash that goes to shareholders. Although, the safety of dividend paying companies is relative. Plenty of big cap dividend paying banks ceased to exist during the financial crisis.

But the big cap Chinese stocks have inherent risks as well. Baidu, for instance, operates at the whim of the Chinese government which could shut down the web portal at any time. It's just too much of a risk for me. I can buy U.S. or European companies in the same industries where there is more transparency and I have a better understanding of the regulatory risks.

3 Big Cap Chinese Stocks

What about those 'better' Big Caps?

Baidu (BIDU), the Chinese search engine, is a Zacks #3 Rank (Hold). It has a market cap of $29 billion. Given that it's in the popular technology sector, plenty of analysts cover the company. There are 16 estimates for 2012.

Shares have come down off their 2012 highs, making this stock more attractive. But it still trades at 23x forward estimates which isn't exactly cheap.

PetroChina (PTR), one of the largest integrated oil companies in the world with a market cap of $220 billion, is a Zacks #3 Rank (Hold). It pays a dividend with a 3.8% yield.

There are 5 estimates for 2012. The $74 billion Statoil has 7 estimates and France's Total has 9 estimates with a market cap of $104 billion.

Shares have slid in 2012 as the oil market turned rocky. The company now has a forward P/E of just 8.8.

China Mobile (CHL) is one of China's largest telecommunications companies with about 670 million customers. The company is a Zacks #4 Rank (Sell). It has a market cap of $222 billion and pays a dividend of 3.7%.

Yet despite the size of the company, Zacks only has 3 estimates for 2012. By comparison there are 4 estimates on Cellcom Israel, with a market cap of just $600 million.

Shares have held up well in 2012 however as investors are anticipating the release of the iPhone in China.

Chinese Stocks Hit The Skids But I'm Still Not Buying

With the recent slowing in the Chinese economy, the Shanghai Index has fallen to a low last seen in March 2009, at the height of the financial crisis.

A few years ago, I might have thought this was a buying opportunity. But even with the sell off, I'm staying clear of Chinese stocks. Maybe I will have missed the opportunity of a lifetime because I lumped all Chinese stocks in one basket.

But I'm still seeing negative headlines about missing CEOs and missing money coming out of China. As an investor, I'm staying broken up.

But like all relationships, there's always a chance at reconciliation somewhere down the road.

Tracey Ryniec is the Value Stock Strategist for Zacks.com. She is also the Editor of the Turnaround Trader and Insider Trader services. You can follow her on twitter at @TraceyRyniec.

BAIDU INC (BIDU): Free Stock Analysis Report

CHINA MOBLE-ADR (CHL): Free Stock Analysis Report

PETROCHINA ADR (PTR): Free Stock Analysis Report

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