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| Biggest Dangers to Avoid Investing in China |
By:
Robert Hsu of chinaprofitstrategy.com |
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In general, the stocks you want to avoid fall into two categories:
1) Chinese stocks that are dangerously vulnerable to market or governmental pressures, and
2) American stocks wrongly hyped as “China plays” by analysts who have no idea what is really happening inside China.
Lets start with state-owned enterprises (SOEs), which are exactly what they sound like: corporations owned by the Chinese government, many of which are publicly traded. They still make up the majority of China’s largest businesses. However, government ownership for most of them is a liability.
You see, in recent years, China has been transitioning from a government-planned economy to a market economy. This has created enormous opportunities for private businesses while at the same time harming the bloated, inefficient SOEs that are not used to responding to the marketplace.
That’s why despite China’s extraordinary growth, you generally want to avoid investing in SOEs. Most have been—and will continue to be—lousy investments.
China’s system of bribes and back-scratching is half voluntary, half coercive and entirely at the expense of U.S. investors. There is no accountability and absolutely no way you can tell what’s going on.
Example: China Aviation Oil covered up huge losses on an energy short trade last year—by simply issuing more stock!
But, tragically, SOEs are the way most outsiders are participating in The China Miracle. These corrupt organizations have sucked an incredible $70 billion out of the West, and the pace is picking up.
Most state-owned enterprises (SOEs) are socialist entitlement programs dressed as capitalist ventures. Example: China Petroleum used to make toothpaste—just to keep workers employed. And several railroad SOEs have joined in the office building craze.
Very often Wall Street analysts know nothing—or at least say nothing—about what goes on in SOEs. After all, they look like blue chips to the unaware! That’s why most of U.S. investors’ money, poured into SOEs in the last five years, may never become profitable.
Imagine the duplicity of Enron, married to the bureaucratic mess of Fannie Mae. Would you put your money in such an enterprise?
My research shows that at least half of SOEs will not survive the next decade in their present form. In fact, the portion of the Chinese economy controlled by the state and the SOEs has already decreased from 90% to 50% during the past 15 years.
I strongly advise you to avoid most state-owned enterprises.
Here are the worst offenders:
• China Aviation Oil Holding Company: This Singapore-listed SOE blew up last year after hiding $550 million in speculative trading losses. Management raised money in a secondary offering with knowledge of the losses only two weeks prior to the blow-up. Now the company is struggling to stay afloat under a restructuring plan while the CEO was briefly jailed in Singapore.
• China Construction Bank: This Hong Kong-listed giant SOE bank was the biggest IPO of the year, but it has seen two of its chairmen fired on corruption charges in recent years. One was sentenced to 12 years in prison. The Chinese government used its immense foreign reserves to temporarily clean up much of the bank’s bad debt prior to its IPO. As long as Chinese banks continue to act as government funding agencies, CCB will be unable to compete with foreign banks moving into China at the end of next year.
• Bank of China, Agriculture Bank, and Industrial and Commercial Bank: Along with China Construction Bank, these three SOE banks make up the four biggest financial institutions in China, and they are also trying to go public soon. These banks have even worse balance sheets than CCB, and in addition to the mountains of bad debt, there are numerous reports of corruption and embezzlement within these companies.
• China Yuchai: Although not officially an SOE, this maker of diesel engines in southwestern China is bound by its 25% minority shareholder—an SOE holding company controlled by the city of Yulin. The 75% majority shareholder, a group from Singapore, needs the cooperation of the minority SOE shareholder to effectively run the company. Large sums of money from China Yuchai have been diverted to companies affiliated with the SOE.
• PetroChina: One of the two Chinese blue chips (the other being China Mobile), PetroChina is China’s largest integrated oil company and counts Warren Buffet’s Berkshire Hathaway as a large shareholder. One of its plants in Jilin exploded recently, leaking 100 tons of toxic chemicals into the Songhua River. For nearly a week, the company tried to cover up news of the toxic contamination until the poison reached Harbin, a city of 3 million inhabitants.
But SOEs Are Not The Whole Story
The real opportunities in China are not government-backed at all. These enterprises spring on to the scene like small tornadoes. The ones that survive have the ability to adapt that is so amazing, it makes even my head spin.
The real millionaire entrepreneurs I meet today in China may be 35 and on their fourth failure—and rapidly moving towards their fifth success. They don’t flaunt their money and they have what I can best describe as…American mid-West values!
These are determined, rigorous leaders who despise the SOE bosses and run rings around them.
Example: A friend of mine, with a nice home in Beverley Hills, returns to his old hometown of Beijing to create high-end software for construction companies. He makes an overnight fortune—at age 70!
But above all, these entrepreneurs are what you might call “clock-builders,” not “clock-watchers.” In other words, they set the pace, do the building, possess the vision. If you were fortunate enough to be part of that tremendous release of inventive energy that the U.S. experienced after World War II, you know exactly what I’m talking about.
And it is with these entrepreneurs that U.S. investors can make stunning fortunes.
WARNING: Avoid Stocks Listed
in Mainland China
The past three years for investors in Chinese stocks have been, to paraphrase Charles Dickens, both the best of times and the worst of times.
For investors in Chinese companies listed in Hong Kong, the past three years have been great. The Hang Seng H Share Index—which consists of 40 Mainland Chinese companies listed on the Hong Kong Stock Exchange—is up a phenomenal 160% since 2003, more than four times the S&P 500 in the same period. On the other hand, Chinese companies (mostly SOEs) listed in the Mainland Shanghai and Shenzhen exchanges were down 30% during the same period.
Given China’s red-hot economy, it’s not surprising that H shares in Hong Kong have been so strong. But what happened to the stocks that trade in Mainland China itself?
There are three main reasons behind their poor performance, and understanding these reasons will put you ahead of most other investors trying to profit from China.
Reason #1: High Valuation. Stocks trading in Mainland China sported a bubbly average P/E ratio of 56 at their peak back in 2000—that is if you believe the earnings numbers. By comparison, the S&P 500 is now trading at 16-times trailing 12-month earnings, or less than one-third the valuation of Mainland stocks at their peak.
At the other extreme, H share Mainland companies listed in Hong Kong were dirt cheap at the beginning of 2003, trading at an average P/E of less than 10. With H shares trading at an 80% discount to their Mainland counterparts, it’s not hard to figure out which was the better buy.
Reason #2: Too Many Stocks Available. As SOEs became increasingly privatized, the state sold massive blocks of shares into the market, which depressed prices. Currently, the government owns approximately two-thirds of all the shares in companies listed on the Shanghai and Shenzhen exchanges, so this will continue to be a huge problem. The Chinese government is starting a series of reforms to alleviate the supply surplus, but it is too early yet to see any result.
Reason #3: Poor-Quality Companies. The third reason behind China’s stock market decline is the poor quality of companies listed in the Mainland Chinese exchanges. China’s top publicly traded companies are listed in Hong Kong and New York. Many of the companies listed in Shanghai and Shenzhen are unable to meet the more rigorous accounting and corporate governance standards required on the Hong Kong and New York exchanges.
Corporate fraud on the order of Enron and WorldCom are common in companies listed in Mainland China. This pervasive corruption and fraud has eroded Chinese investor confidence, further contributing to China’s stock market decline.
None of these three issues will be resolved anytime soon, so you want to stay away from companies traded on the Shanghai and Shenzhen exchanges.
The best Chinese stocks are those listed on exchanges outside of Mainland China.
I’m begging you not to invest in China unless you have “boots-on-the-ground” experts who know what’s really going on. The so-called China Miracle you keep hearing about in the mass media is a setup: ordinary investors are taking the bait and swallowing the lie.
I don’t want you to be one of them.
Avoid These Chinese Companies Traded in America
The following stocks are Chinese companies traded on American exchanges. But just because they are based in China doesn’t mean they are smart investments in the growth taking place there. The companies listed below are vulnerable to a variety of factors, from poor management to market forces to government interference.
Let me say that my list here does not include stocks trading under $10 a share. Those companies are likely to have poor fundamentals that are already reflected in their low share prices, and many have already been branded as losers. Instead, I wanted to focus on bigger companies that you may have been tempted to invest in:
...FOR THE REST OF THE ARTICLE AND THE TABLE OF STOCKS TO AVOID, VISIT:
http://www.chinaprofitstrategy.com/ |
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