NEW YORK ( Stockpickr) -- Sometime over the course of 2011, a collective light bulb went off among investors: "Why on earth would you invest in Chinese stocks?"

After all, many of these stocks sneaked into the public market space by merging into an existing shell company, avoiding the scrutiny that comes from an initial public offering process. And it became apparent that the auditors that were verifying these company's financial statements were really just giving the equivalent of a priest's blessing, waving a hand over the books and nodding their approval.

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After several high-profile blowup such as China MediaExpress and Rino International, neither of which had any real business underlying their specious financial statements, the whole group has been tarred and feathered. So you should have some pity for the Chinese companies that actually do play by the rules, have real businesses, and can only sit by as their stock gets tossed into the trash bin with their more dubious peers.

Here are three Chinese stocks that are legitimate and now quite undervalued.

Deer Consumer Products

Deer Consumer Products ( DEER) got its start as a contract manufacturer of household appliances for U.S. branded firms such as Stanley Black & Decker ( SWK). In recent years, Deer has sought to augment that low-margin business with its own sales efforts in China. The company's products can now be found in 3,200 stores across China. Using its own name on products and selling directly into the Chinese market brings stronger profit margins.

The domestic expansion has helped propel the top line as sales rose from $33 million in 2007 to a projected $225 million in 2011. Third-quarter results reflect continued momentum as sales grew 32% to $73 million from a year ago, and EPS rose 39% to $0.39.

Yet it's pretty clear that a sub-$6 stock with projected EPS above $1 has plenty of detractors. Several short-sellers came out with scathing reports earlier this year alleging false transaction prices for real estate purchases. Those accusations never came home to roost, though the company was less than forthcoming with any its response, except to express deep frustration.

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Another possible concern: Inventories rose a hefty 78% in the third quarter (compared to a year ago) to $40 million, which is twice the rate of sales growth. Management contends that this is part of a strategy to boost stocking levels at retail stores, but this is surely a metric worth monitoring in coming quarters.

But there are real positives here as well. For example, insiders have agreed to restrict any stock sales until 2013. If this were a house of cards, the company would likely implode long before 2013. And the company now offers up a 20-cent annual dividend that equates to a 3.8% yield. This isn't a risk-free stock, but a P/E ratio below five times (trailing earnings) more than discounts the risks involved.

Deer is one of TheStreet Ratings' top-rated home appliance stocks as well as one of the top-yielding consumer durables stocks.

Bitauto Holdings

Global auto makers are pouring all sorts of resources into China, opening local factories and even designing cars more suited to local tastes. GM's ( GM) Buick division designed its recently refreshed Regal in China to be sure it could help maintain that brand's allure in what is now the largest car market in the world. (JDPower thinks Chinese car sales will top 20 million by 2013, up from 17 million in 2010.)

Chinese consumers, spoiled for choice as the range of new models keeps expanding, are turning to the Internet to research before buying. And more of them are turning to Bitauto Holdings ( BITA), which provides product reviews and syndicates that content out to many leading Chinese portals. Car dealers pay Bitauto to run classified ads and marketing campaigns.

Bitauto looked like it might be a promising IPO when it debuted last December at $12. Sales in 2010 were on track to rise more than 50% to an eventual $458 million, and operating profits of $67 million rose by a commensurate amount.

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But shares have fallen more than 50% from that peak and now trade under $5. In some trading sessions, trading volume slips below 50,000. It's as if the only-recent IPO has already been forgotten. Yet this company actually remains quite healthy. Third-quarter sales rose 47% -- 10% above management's guidance and GAAP earnings rose 34% from a year ago. That kind of growth looks sustainable. Online ads account for 30% of all U.S. advertising here in the U.S. but just 10% in China. As Chinese auto makers bump up their online marketing efforts, BitAuto will be a clear beneficiary.

The key reason behind the stock selloff: Management has been spending heavily on staff and resources to handle higher volumes, so EPS will likely being stuck in the 30 cents to 35 cents range in 2011 and 2012, as was the case with 2010. As that spending levels off in coming quarters, investors will better trust that 2013 profit results will become as robust as the top-line gains, and this stock may make a move back towards its low teens IPO price.

Bitauto is one of the holdings at Chase Coleman's Tiger Global Management.

China Lodging Group

Spending on tourism has been one of the strongest hallmarks of rising consumer spending. An overwhelming majority of Chinese citizens prefer to travel around their own country rather than venture abroad. Valued at $1.5 billion, Home Inns & Hotel Management ( HMIN) may seem to be one of the best investing angles on an expanding appetite for Chinese hotel rooms, but China Lodging Group ( HTHT), with a somewhat smaller $900 million market value, may actually be the more appealing play.

The key difference: Home Inns has a growth-through-acquisition strategy and often overpays for acquired properties, whereas China Lodging focuses on slower-but-safer organic expansion. Still, projected 30% revenue growth in 2011 and 2012 is nothing to sneeze at.

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The biggest risk for these stocks isn't possible fraud but possible overexpansion. There's a decent chance that China would find itself with a glut of hotel space if the Chinese economy hit the skids. That would surely pressure these stocks in the near-term, but as is the case with the broader global lodging sector, new construction freezes and then demand eventually catches up with and overtakes supply.

That's not a problem for now as China Lodging just boosted EBITDA margins 110 basis points sequentially in the third quarter on the heels of firmer room rates. There's more to come, according to Sterne Agee: "We see gradual margin improvement as more new hotels become mature," adding that "as a robust 2012‐2013 growth story, we see significant value to be unlocked from the stock during the next 9‐12 months."

Sterne Agee's $26 price target, which is roughly 70% above current levels, would put the stock right back in the range of the 52-week high seen early in 2011 before Chinese stocks started to crumble.


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At the time of publication, author had no positions in stocks mentioned.