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China New Energy a Buy, Ignore the Math

Stocks in this article: NEWN.OB

First, they are simply an accounting entry that does not reflect economic reality. The reality is that shares were issued in order to acquire incremental profits. If we use the proper share count of 12.6 million, then the additional non-cash charges are superfluous.

Second, because the company did not issue convertibles or warrants, the charges are one-time charges only and will not affect the business going forward. How much will the non-cash charges be? I don't know because the company did not disclose it. But frankly, I don't care how much they are because they are irrelevant to the business in 2010.

On the day that earnings are released, some investors may simply look at the bottom line EPS, including non-cash charges, and conclude that profitability was lower than expected. As a result, there may be some selling pressure that day, which I will view as a good opportunity to pick up more shares.

On the other hand, given that the company has been so proactive about communicating guidance, there may be no negative reaction at all. In any event, I always try to be careful to not get fooled by non-cash earnings charges related to acquisitions and share issuances.

The company released detailed guidance for 2010 projecting EPS of $1.23, which implies a forward PE of only 6.1 times, despite a projected tripling of net income. For a pre- Nasdaq stock, this valuation looks somewhat cheap. But the real upside here is that the company has already publicly announced its intentions to uplist and has said it will do so in 2010.

Once this happens, NEWN should trade on a multiple closer to that of its other Nasdaq-listed peers. That's where the current valuation becomes compelling.

Advanced Battery, Hong Kong High Power and China Ritar all trade in a consistent range of 13-19 times earnings. So what is the "right price" for New Energy Systems?

I use the following assumptions: 2010 earnings as guided of $15.6 million, shares outstanding as indicated of 12.6 million, for an EPS of $1.23. Once NEWN uplists, I would expect it to trade at a P/E in line with China Ritar and ABAT at around 13x, implying a share price of $16.12.

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