RE: The Perils of Investing in China...
Small Cap China stocks traded in the U.S.:
Sentiment towards the group is excellent from a contrarian standpoint.
That sentiment is animosity, fear, and a good deal of loathing.
As to the guy who went over and visited 50 U.S. listed small cap companies in 60 days.
Have you [dear reader, not Newly specifically] thought that one through?
Think about what it involves logistically for an American to go to China [most likely does not speak the language or read their writing], live out of hotels, figure out transportation, the time involved in getting from one place to another in this country that is bigger than the United States.
How would you, an American, [very familiar with this country, transportation, and language] do visiting 50 small cap U.S. listed companies in the United States in 60 days. How could you physically do it [and learn anything truly important that the market does not already know]
How good could your DD possibly be in determining whether they are fraudulent?
It is no secret that investing in China is investing in a tough neighborhood.
But, one should not be smug in America.
In the last 30 years we have received at least 20 notices from a Court somewhere in this country, informing of us that we may have been a shareholder during a block of time several years previous, and it has been determined a SC company we once owned was involved in fraud, thus we may be eligible for our share of a settlement the court handed down. None of these settlements, usually in the $10 to $100 million range were big enough to be newsworthy. Fraud happens more than you would believe, you just don't hear about it unless you were at all close to the situation or have owned a ton of small cap U.S. companies.
Keep in mind that these are only one's we know about. It doesn't include the vastly greater number we do not know about. It does not include those who were fraudulent and got away with it.
Then there was Enron and WorldCom. Audited by white shoe-blue chip auditors, followed by dozens of analysts and they were frauds. Our mother even lost a bunch because she owned a safe utility for 30 years that was bought by Enron for Enron stock instead of cash.
Then there is the matter of Criminal Stupidity on the part of supposedly top notch managements of blue chip companies. Most likely there was highly unethical behavior in addition to criminal stupidity that cost investors $hundreds of Billions of dollars. Citi, WAMU, LEH, The Fannie trio of mac, mae, indy, Bear Stearns and many others.
Where were the blue chip auditors in warning investors that these companies were a dangerous pyramid of cards with undecipherable derivative positions of unknown quantity located who knows where? Companies that were time bombs waiting to go off with a down tick in home values. [leveraged 35 to 1].
This does not minimize risks of investing in China SC companies, but the bottom line is that American investors have also lived with a pool of Mako sharks and have lost more collectively than the entire market cap of China SC companies because of fraud or criminal stupidity and a nod and a wink from our prestigious auditors.
The market is a good discounting mechanism that prices fear, loathing, and animosity as well as profits, losses, future prospects.
Almost all China SC stocks are priced with the assumption there is a fairly high probability of the numbers being reported by the company being fraudulent.
There is substantial upside in those companies that are clean when, over time, investors come to believe the companies are legitimate and reporting accurate numbers.
Last,
Who has the most to lose as owners of China SC stocks if the managements are crooked?? [and the fraud is discovered which it usually is in due time]
Answer: The managements and insiders
Ex: The CEO of Harbin owns over 10 Million shares [over 30%].
Insiders and 5% owners hold 44% of GFRE shares, institutions 17%
A $2 pe share swing in Harbin affects the net worth of the Harbin CEO by $20 million.
While this does not prevent unethical or even fraudulent behavior, with the scrutiny and punishment these China SC stocks are receiving, it is hard to imagine even one of these CEO's not being aware of the heavy personal financial consequences of fraud.
In most cases,we would propose, they have far more to gain by being ethical than they do by being fraudulent. If they did not get it before...there is a good chance they are getting it now.
These are just some things to consider when reading the weekly articles warning of China fraud and stay clear.
Stay clear if it suits you, that's fine, but realize the issue is more complex than some seem to believe it is.
Profits can be made although losses will have to be taken in the process. [Just as it always has been with a pool of American SC companies we have bought in the past].
The only way we were able to get GFRE for under a $buck was buying into the teeth of fear when others thought buying it was crazy. There was a wall of fear and GFRE was priced accordingly. Same for HRBN when it was truly cheap 2 yrs ago.
Timing wise, we do not know when the cloud will lift. It has become a lucrative cottage industry shorting a China SC stock, then putting out a very negative article on it. [whether true or not].
As long as it works, they will keep doing it. The SEC seems content in turning a blind eye to what in some cases is almost certainly illegal behavior.
If the market gets a long overdue correction, it has been the case previously that China SC stocks traded in the U.S. generally go down with it, so we're not even saying the worst is over.
We have confidence that truth [whether "good" or "bad"] and valuation will win out in the end and those who can gain hold of solid growing companies in China that are ethical, stand to make a lot of money because of todays depressed valuations.
Fabian
