China IPOs - A Surefire Way to Make Money?

Seldom a day goes by now without some kind of coverage of how well US-listed China IPOs are doing vis-a-vis their domestic counterparts.

So far this year, 19 China-based stocks have listed in the US and six more are currently in the pipeline. Amid the eagerness that awaits these offerings, many are already trying to put a lid on the frothy bullishness.

A recent Reuters article quoted University of Florida finance professor Jay Ritter: "The high price to earnings ratios are really hard to justify, and the mistake investors make is confusing growth in the Chinese economy with growth in earnings per share of Chinese publicly traded companies." Professor Ritter estimates that domestic Chinese stocks are trading as high as 60 times a company's earnings, and US-listed Chinese stocks are not far behind in valuation.

The Wall Street Journal today cited an expert: "I can't really think of anything right now that's going to undermine the Chinese miracle, but I'll bet if you asked people in January 2000 what would do it to Nasdaq, I don't think anyone could have come up with anything then, either."

Personally, I don't think alarm bells need to be sounded. Let the Chinese party continue if it's a reflection of the upbeat sentiments of China's economic growth. But investors should not turn a blind eye to the risks too, namely credible information.

Last week, the Journal highlighted that foreign research firms are expanding their China-based teams to offer sorely lacking information on small-cap mainland stocks. The idea is to improve liquidity and reduce volatility.

But to get an accurate picture of the company's health, research runs the whole gamut from talking to the CEO, CFO, suppliers, customers, industry associations, to digging into related-party transactions, capital structure, etc etc.

I really doubt the brokerages will be willing to devote the extensive resources needed for this type of work. As it is, the hunt for hidden gems will intensify as both the New York Stock Exchange and Nasdaq recently opened their China offices to sell their bourses. With more Chinese firms likely to list here, stretched resources will almost certainly mean little research/coverage for the small, remotely-based companies.

Will these stocks turn into pure speculative plays then?

Certainly, the situation in the US is no different from the rest of Asia, where investors trample over each other to get their hands on a Chinese stock. In Singapore, red stocks are all the rage but they are also extremely volatile and every so often, news would filter through of sudden management changes, profit warnings and the like. The bigger and better firms played a saavy PR hand, and would invite analysts and journalists to visit their operations. But the smaller firms often slipped under the radar or would burst into play for no tangible reason.

So the stakes are certainly high. It's no doubt trite advice, but get into the game at your own risk.