Avoid These Chinese Microcaps

When we finally look back on 2011, we could very well label it the “Year of the Chinese Fraud.” Not a day goes by without some sort of scandal breaking out regarding an American-listed Chinese company.

It’s not just penny stocks, either. Earlier this week, the NYSE began the delisting process for Duoyuan Printing (NYSE: DYP), a company the SEC is investigating for fraud. Other reverse mergers have sparked investigations, as well as criticism from various financial blogs. Companies such as China Integrated Energy Inc. (NASDAQ: CBEH), China MediaExpress Holdings (NASDAQ: CCME) and Deer Consumer Products (NASDAQ: DEER) have all been in the spotlight this month due to fraud allegations, some relating to reverse mergers.

The anti-China sentiment has put many investors on high alert. It’s gotten to the point where a single negative article or blog posting can spark panic selling. In fact, many of the stocks I’ve already mentioned have suffered near-catastrophic losses in just a short time frame. Some of the fallout has been attributed not to regulatory action, but to analysts, journalists and bloggers.

Complacency plays a large role, in my opinion. Investors will see a Chinese company listed on the Nasdaq or NYSE and automatically assume it to be completely legitimate. However, it is important to remember that complying with an exchange and producing timely SEC filings do not guarantee squeaky-clean management and business practices. You simply cannot rely on a major stock exchange to validate any company, whether it is domestic or foreign. This chore falls upon you and your research.

These recent American-listed Chinese company scandals are also revealing the thought process of many uninformed investors. As the market is now showing us, it has become painfully evident that those who have been speculating on Chinese microcaps have not bothered to digest all of the publicly available information into consideration before buying shares. Much of the research that has gone into “exposing” recent shady activity has not been provided by whistleblowers or in-depth investigations, but rather a thorough look at a company’s public documents by researchers with nothing more than an internet connection.

It is now clear that the climate of speculation regarding publicly listed Chinese companies has abruptly shifted. For now, the market has spoken. Investors want nothing to do with most American-listed Chinese companies. Until this critical point changes, these stocks will continue suffer.

Unless you intend to play them on the short side, I would avoid these Chinese companies at all costs. What began as a few isolated instances of fraud is now turning into an epidemic. Don’t get caught up in it, because I wouldn’t be surprised to see the current panic spread even further before it’s all said and done.

Sincerely,

Greg Guenthner
Penny Sleuth

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