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Strategies & Market Trends : John Pitera's Market Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: John Pitera who wrote (7615)	3/9/2007 3:29:21 PM
From: John Pitera	Read Replies (1) \| Respond to of 33421

Chinese stocks are wild now. Wait until Beijing's new accounting rules take effect. Elizabeth MacDonald 03.26.07 Behind the recent, gut-clenching stock market volatility in China is a disquieting reality: China's rotten accounting. If you thought the Shanghai index's 8.8% drop in late February was bad, wait until a bunch of rickety Chinese companies collapse. That's the dour outlook from ace China-watcher Brian Hamilton, who runs stock research firm Sageworks in Research Triangle Park, N.C. "Investors in China tend to buy and sell according to price movements, not fundamentals," Hamilton says. "But too often with China's stocks, there are no fundamentals to be found." Stocks are a big fad in China--a worrisome situation. The old warning holds true: Once the shoeshine guy is playing the market, it's time to step out. The stock-buying frenzy began early last year, when the Chinese government converted $250 billion in nontradable shares in mostly state-owned enterprises into tradable ones. Since then investors have been pouring into China's Shanghai and Shenzhen stock markets. With price gains and new issues the combined market value of these exchanges climbed from $400 billion at the end of 2005 to $1.5 trillion on Mar. 4. The average price/earnings ratio in China is 63. All this has spooked government officials. To drain liquidity out of the market, China has been moving to reduce its banks' lending capacity by forcing them to keep more capital in reserve, as investors opened 50,000 retail brokerage accounts a day in December, and mutual funds raised a record $50 million last year, quadruple the 2005 amount. But Hamilton thinks that move still won't stop market swings. That's because investors are about to see much more detail on China's corporate earnings, and the picture may not be pretty. With its accession to the World Trade Organization in 2001 China promised to open up its accounting sector to foreign accounting firms. China decreed Jan. 1 that its listed companies must book their profits under a new set of accounting rules. But what's eventually unearthed just might set off panics among small investors. The new rules are based on--but not identical to--the international accounting standards increasingly used in most markets. That means much more detail in a secret economy, where even the most basic line items like debt and development costs were hard to come by, says Stephen Chipman, an expert on China's financial systems at Grant Thornton. Now companies will have to do things like quickly write off obsolete inventory and uncollectible receivables. That's a novel concept there. Financial fraud has been plaguing China's effort to mingle freewheeling capitalism with its murky centrally planned economy. The country's police recently announced that they have uncovered 400,000 cases of economic crimes and arrested 370,000 suspects over the past seven years, recovering $12.9 billion. The harsh prison sentences meted out to Enron's Jeffrey Skilling and WorldCom's Bernard Ebbers are nothing compared with the sentences Chinese authorities handed two embezzlers: Zhou Limin, a former branch president of China Construction Bank, and Liu Yibin, an accountant, will be executed for filching $25 million. Given the radical shift that the new rules call for, compliance will hardly be perfect. Since the 1949 revolution China generally hasn't had an objective accounting profession because it discourages dissent. Accountants were routinely packed off to reeducation camps in the 1960s. Would a place that still jails reporters for revealing corruption really protect accountants who are just doing their job? China has only 70,000 accountants, say state-run media. On a per capita basis, the U.S. has 40 times as many. After getting an M.B.A. at Duke, Hamilton, now 44, founded a firm to oversee the financial work of small companies. Then he started up Sageworks, which sells financial research to the likes of Citigroup. In 2003 it tackled the enigmatic world of Chinese investing. To rate the shares traded in Shanghai and Shenzhen, Hamilton uses software to assess 26 metrics like profit margins, debt and assets. Despite his qualms about the accounting, Hamilton still thinks fast-growing China is a good investment opportunity. He has a list of five such stocks, and another quintet to avoid or sell (see table). Most of them are available as American Depositary Receipts and generally reconcile their numbers according to U.S. accounting rules. The good five show increasing sales, an average net margin of 38%, a low ratio of accounts payable to sales and a high ratio of sales to assets, among other things. Example: NetEase.com, which operates an interactive online and wireless community. Net income doubled to $120 million in 2005 and shot to $161 million in 2006. And the bad? Hamilton singles out China TechFaith Wireless Communication Technology, a telecom company that dipped into the red last year. The problem: It can't get a grip on costs. For 2006 its cost of goods sold rose 57% to $55 million while its top line decreased 10% to $81 million in 2006. For a company struggling with costs, tougher accounting rules can only bring bad news. -- Forbes 03-26-07