Euro Tech's Ripe for Scam

I love looking at the daily charts for actives, gainers, and losers. It may not be the best way to find investment ideas, but it is a great way to find out about investor groupthink. Yesterday, the gainers table featured a horrifying and instructive example of a group that's clearly not thinking. I'm talking about anyone who bought shares of Euro Tech Holdings (Nasdaq: CLWT) yesterday, driving it up 154% to $7.80 on 100 times its usual daily volume. The 10 million shares that changed hands represent more than 5 times the float.

The financial press posted stories about the stock's meteoric rise, but made no attempt to explain what is going on. When a Hong Kong penny stock, incorporated in the British Virgin Islands, sees its dollar volume jump from less than $500,000 to more than $70 million in one day, some investigation is in order, or at least the basic facts. Let's look at a few.

Though the firm does business in China, this is not the next Sohu.com (Nasdaq: SOHU), Sina (Nasdaq: SINA), China Life Insurance (NYSE: LFC), or Nam Tai Electronics (NYSE: NTE). Euro Tech is a holding company that sells a variety of technical instruments and measuring systems for water and wastewater treatment. Translation: It's a wholesaler.

Its annual earnings release this week showed a 17% increase in revenues, and its 6% increase in net earnings. There's also a "stock dividend" that may have jump-started the irrational exuberance, though anyone should know that the 5-for-10 dividend is just a 3-for-2 split by another name. If you like your pizza cut in 15 slices, then good for you. Just remember that the pie's not getting any bigger.

Splits like this are often dubious (why does a $4 stock need to be a $2.67 stock?); otherwise, Euro Tech looks respectable enough. Over the past six years, revenues have compounded at an annual rate of 9% and earnings per share at 12%. That put last year's sales at $27.4 million and earnings at $0.12 per share. But does a slow-growing foreign company in a high-risk economy deserve a P/E of 65? Of course not, especially with a net profit margin of 2% and a return on equity of 7%.

The low float makes the stock ripe for gaming. Witness the so-called "press releases" provided by penny-stock hypesters. Beware these providers of "news" that "reserve the right" to trade in securities mentioned.

Folks, this is how penny-stock scams work, and more than a few people are going to get burned. Watch if you must, but if you consider cracking open your checkbook, keep your eye on the business, not on the chart.

For good information on investing in China, check out the Fool's China Connection board.

Fool contributor Seth Jayson does not reserve the right to trade in stocks he mentions, at least not right away. In fact, he has no position in any company above. View his Fool profile here.