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A Dose of Reality Needed for China Fever

Stocks in this article: DANG RENN YOKU DATE (DATE) recently posted its first quarterly profit, but only as a result of dramatically cutting marketing expenses. It has already announced that there will be no growth in revenue in the fourth quarter, so it is expected that DATE will swing back to a loss once again. The company did recently announce a share buyback plan, which helped to support the share price. But with less than $100 million in cash, buying back shares could be a very risky strategy and it is unlikely the company will pursue this. The company currently trades on a trailing P/E of over 200. I was previously short DATE at just over $6.00, but scrambled to cover once the stock took off.

Most noteworthy is E-Commercre China DangDang (DANG). Shares of DangDang are up a stunning 83% as investors seem to be experiencing a relapse of China Internet fever. Since the time of its IPO, DANG has been labeled as the of China. However in the same way that RENN is not Facebook, DANG is not AMZN. The simplifying analogy may be useful in selling an IPO to investors, but it is far from useful in valuing the company. The following summary income statement speaks for itself.

As can be seen above, growth in revenue is decent but not spectacular. Everything else is downright terrible. Gross margins have fallen in half and are approaching single digits. Moreover, despite being previously profitable, DANG has swung to losses and these losses are accelerating. Revenue is expected to grow substantially in the fourth quarter, but once again the net loss is expected to widen. It is worth noting that even when it was a profitable company, DANG could only achieve a net margin of 2% to 5%.

It is the beginning of a new year and many investors are trying to make up for a difficult 2011 by chasing names that have potential to be multi-bagger stocks. A number of recent articles have touted that buying DANG at $6 to $7 is like buying AMZN at $6 to $7 many years ago. However, this just isn't the case.

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