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Three 'Probe-Proof' China Stocks for 2011

Investing in SBAY has largely been a painful experience. Despite a seemingly insatiable appetite in 2010 for online-related China IPO's by U.S. investors, shares of SBAY have languished and in fourth-quarter 2010 fell from a price of over $12.00 to a low of $5.99. Trading the stock is particularly difficult.

In December, when the price of SBAY was around $7.45, I noticed that the bid was only $7.30, while the ask was as high as $7.70. This represents incredible illiquidity for a Nasdaq-traded stock and a single trade of only 100 shares can make the stock appear to have moved up by several percent or down by several percent when it is really just a single small trade moving the stock.

On December 20, the stock reached an intraday low of $5.99 despite the fact that the company had already re-affirmed 2011 guidance of $3.69 per share. This represents a forward PE of 1.62. On December 23, the company released earnings that disclosed a net loss for the year, yet the stock rose by as much as 45% during the day on 15-20 times average volume, closing the day up 43%. It was a huge move on huge volume, despite the announcement of a net loss.

I believe a significant part of the move was driven by SBAY's announcement that going forward, it would be using PWC as its auditor. I believe that auditor upgrades will be a key driver of select stock prices in 2011.

SBAY now trades at $9.20 (prices are as of Dec. 23), volume was huge and the bid asked tightened to just a few cents. The stock trades at only 2.5 times 2011 projected earnings. When the stock moves, it moves big. However, it is one that can also be very frustrating. From these levels, and given the low valuation, the stock could easily double in 2011. The concerns I need to address before buying include:

  • Getting a better understanding of the 2010 net loss and getting comfortable that it won't be repeated (i.e., will the company be able to meet 2011 guidance)

  • Identifying the catalysts that will make investors jump on board (including getting a better understanding of the company's efforts to get its story out to Wall St)

  • Getting past dilution concerns, particularly given the substantial dilution in 2010.

China Media Express

Another thing I try to avoid (but which I am doing right now) is writing about stocks that are too "in fashion," and which everyone else seems to already be focusing on. CCME is very much in fashion by the longs. I have received recommendations on this stock via tweets, emails, phone calls and in person. The company provides TV advertising on inter-city buses in China, basically bombarding a captive audience with ads.

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