By now anyone who invests in China stocks is familiar with the carnage going on with the stock of Rino International (RINO). On Nov.10, the Hong Kong based research duo (and dedicated short seller) known as Muddy Waters produced a 30-page report on Rino declaring it to be an abject fraud and with a target price of $2.45 vs. its then price of around $15.00.
The stock has now been halted and the share price stands at $6.07, a decline of 60% in seven days. Their auditor, Frazer Frost, came out on Friday and confirmed that there were in fact phony contracts with revenues that didn't exist and other irregularities. I have been following this situation closely and I feel that there are a number of important lessons that can be learned from it.
Readers may remember that Muddy Waters and I have a somewhat strained history following their report on Orient Paper (ONP) in June 2010. By pure coincidence we had happened to tour the ONP facilities on the same day in January 2010. Where I saw opportunity, they saw fraud. What ensued was an acrimonious online battle of words between the two of us as to whether or not the company was a fraud.
When MW first released their report, ONP stood at $8 and they declared a target price of "less than $1." The stock bottomed at about $4 but recently rebounded to as high as $7.67, almost a double. MW has gained significant credibility due to its extremely accurate and timely call on Rino and now many investors are rethinking their refound confidence in ONP and have been dumping the stock. It now stands at $5.58 -- 28% below its recent high. There is currently an independent investigation under way being conducted by accounting firm Deloitte & Touche and law firm Loeb & Loeb, so the final verdict on ONP will have to wait for the results of this investigation.There are a number of key lessons that investors can take away from situations like this.
Lesson #1. Shoot first, ask questions laterWhen a serious and detailed allegation of fraud surfaces, sell. Sell immediately. In the case of both ONP and Rino, the stock "only" fell 15% upon the release of the report. It was only after the report became more widely disseminated and was joined by other vocal online short sellers that the share prices took the 50-60% dive. I have seen this in the case of many other stocks including (UTA), (FUQI), (NEP) and others. Consider the first 15% to be a warning shot and take notice. It may be tough to swallow the loss but it is better than what will come next.
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