Same Movie- But Different Ending For Different People

Forget about the short term trading issues in these China situations for a moment, and let's look at a bigger and far more interesting issue. Here's some reasonable EPS estimates for several of our China based companies- CREG- $.25 to $.30 EPS in '09; NFEC- $.47 to $.60 in EPS in '09; UTA- $1.20 in EPS in '09; CEU- $.60 to $.75 in EPS in '09.

What do all this companies have in common? Strong top line growth, great margins, no debt, and very low valuations. Valuing companies in order to predict what the market might be willing to say they are worth down the road is tricky business.

There's a couple of old rules of thumb one can go buy. PE Ratio (Price to Earnings) as a measure of value has been used for years, and every analyst uses this measure as one component of their research. The mature behemoths of the DOW tend to trade at a PE multiple of 10 to 12- another words, the stock trades at 10 to 12 times EPS. Growth companies tend to trade at much higher multiples- 20 to 100 times EPS. Here's a rule for long term investors that has worked for years- A stock will eventually trade at a PE equivalent to 1/2 its growth rate.

So, let's take CEU as an example. The company has reported about 80% growth so far this year. This suggests the stock will eventually trade about a PE of about 1/2 it's growth rate- 40. Based on the first half of '09, the company will earn at least $.60 this year. 40x.$.60 = $24. Yet the stock is only trading at $5. How can this be?

Here's a case where there's a lot of people watching the same movie, but drawing different conclusions. The answer can be found in the general skepticism that pervades everything China.

The movie I'm watching is about a country exploding with commerce, boasting the largest emerging consumer class in history, and a government committed to infrastructure, green technologies, education, health care, and the general well being of its citizens.

Here's an anecdotal story for you. This past Monday night I had dinner with a hedge fund manager who had just returned from 3 weeks in China. Over the course of that 3 weeks, this guy visited 26 different companies. He told me the level of commerce and activity was through the roof, and management was willing to meet in the evenings, weekends- anytime.

He told me it was an eye opening experience, and likened it to visiting Silicon Valley in the early to mid 90's- and we all know how that turned out.

Recent articles I have also call into question the "quality" of earnings companies are reporting. For example, LDK Solar (NYSE: LDK) and Yingli Green Energy (NYSE: YGE) had the quality of their earnings questioned by some analysts.

There have been numerous allegations Chinese companies have poor corporate governance and "shady dealings" going on behind the scenes.

Then, there's the issue of the "C" word- Communist- many point out China is a communist country to this day, and hence can't be trusted. I would suggest the opposite is true as it relates to growth and a business friendly environment.

It's true- the Communist Party rules China. If we're going to liken investing in China to investing in the US in the '50's times 28, then we have to compare business friendly governments.

The Chinese government is still communist, but it's as capitalistic as it gets. I would suggest China offers a better business environment than the 50's version of the US.

In China, when the government decides to do something, they do it the next day. There's no bureaucracy. A watered down version of a stimulus bill doesn't take 8 months to go through Congress where it comes out laden with special interest pork. Just the opposite is true. In China, a stimulus package is decided and acted on in a nano second.

The Chinese government is moving rapidly to clear up these "misconceptions" about what's going on in China. They are moving even more rapidly to clean up their highly polluted air, and move their economy from export driven to internally driven growth.

What's the ending in your version of the movie? Do you believe as I do in two years we'll be looking back and wondering why we didn't back up the truck on some of these valuations. Surely, as time goes by, and these companies become more attractive to Western capital, the valuations will find their way to more typical US type multiples.

Or, are you a skeptic? Are you having a hard time believing the numbers are this good? If so, you might want to seek growth elsewhere, but you won't find it as easily in the US.

I believe the market's skepticism is our opportunity, and I'll need 1 to 2 years to be proven right.