Finding Gold in Cash-Rich China Stocks

Editor's note: This is the first in a series of stories on cash-rich China stocks that are poised to benefit from growth in the country's economy.

BEIJING (TheStreet) My "target" for a good opportunity in a cash-rich China stock is where cash is at least 40% of market cap. This will clearly be a moving target as prices change every day.

There are two reasons why cash-rich China stocks can be the source of significant hidden value. First, headline P/E numbers provided by the financial media do not back out cash. For companies with a low to moderate amount of cash, this doesn't change the picture much. However, for companies with a large cash balance, the "true" economic P/E is actually much lower than what many people may realize.

Second, many people (myself included), view the Chinese yuan as a fundamentally undervalued currency that will inevitably appreciate as the Chinese government reduces intervention in response to growing international pressure. Although this appreciation is expected to be a slow, gradual process, large cash balances can be seen as a large undervalued asset on the books.

One great example of this type of stock is Shenzhen-based Cogo Group(COGO Quote), which provides module and subsystem designs to mobile phone and telecom equipment manufacturers in China.

At a price of $6.14, COGO is trading at a market cap of $221 million, a multiple of 35 times trailing 12-month earnings. However, in a recent 10-Q released on Aug. 6, COGO maintains a balance of $118 million in cash and pledged bank deposits, 53% of its market cap. Backing out the cash results in a "cash-adjusted" P/E of only 16 times trailing 12-month earnings.