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Separating Winners From Losers in China

So right about now, readers may be thinking that this could look like a great opportunity to short an overvalued stock. Because stock prices are unpredictable, I would certainly caution against it. The best example of the risk in this type of trade is China BAK Battery (CBAK - Get Report).

China BAK Battery looks like a great candidate to short because it is another consistent money-loser and will most likely need to continue diluting shareholders by financing with equity.

But an unfounded rumor in December suggested that it had won a contract from Google (GOOG), sending shares soaring 65% in one day on 30 times normal volume. In September, China BAK Battery rose from around $3 to nearly $5 in two weeks for no reason other than the hype surrounding the A123 Systems IPO. A few weeks later it reported that it once again lost money for the quarter, but less than in the previous three money-losing quarters.

Because money-losing stocks do not trade in line with their fundamentals, they are an easy way to lose money whether you are long or short. As a result, it only makes sense to stick with companies that are strong and consistent money makers. This sounds obvious, but clearly many investors do not make this a practice.

A good comparison here is Synutra (SYUT) vs. American Dairy (ADY). Both of these companies are Chinese dairy operations, however that is where the similarities end. After being massively impacted by the melamine tragedy in 2008, Synutra has lost money every quarter. By contrast, American Dairy has been consistently profitable.

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