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China Stock Fraud News Already Priced In

Now that fraud in China stocks is front page news, many people have been asking me if it is "game over" for the China small-cap space. I continue to give the same answer -- in 2009 the whole space traded up while in 2010 the whole space traded down. I believe that 2011 will be the year when investors start to actually focus on the details, including auditors and red flags, and start to truly differentiate between good companies and bad companies, rather than simply buying up everything China-related or simply selling off everything China-related.

A year from now, as we are looking back on 2011, we will undoubtedly see several things. Many stocks will simply trade within their ranges. We will almost certainly see more price-crushing frauds. But at the same time, without question, there will still be a number of doubles and triples to be found.

The first rule of trading is don't lose money. So it will be important to do everything possible to avoid the next Rino (RINO). But at the same time, with dozens of companies trading at prce-to-earnings multiples of 5, 6 and 7, there will certainly be very company-specific opportunities for significant appreciation in 2011.

After the holidays, I will once again begin traveling extensively through various parts of China to view company facilities and interview management teams. My goal is to identify those few companies with the least red flags and which provide the strongest auditor comfort in hopes of finding the potential outperformers of 2011. I will post my findings here at TheStreet with an extra emphasis on these red flags as well as details on the auditors of the companies and I hope that readers will find it useful.

Pearson has no positions in the stocks mentioned.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

Rick Pearson is a Beijing-based private investor focusing on U.S.-listed China small-cap stocks. Until 2005, Pearson was a director at Deutsche Bank, spending nine years in equity capital markets in New York, Hong Kong and London. Previously, he spent time working in venture capital in Beijing. Mr. Pearson graduated magna cum laude with a degree in finance from the University of Southern California and studied Mandarin for six years. He has frequently lived, worked and traveled in China since 1992.
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