Are Chinese Stocks in Trouble?

If you're a believer in Chinese growth stocks -- and I am -- the past few weeks have been painful.

It's more than just the global market malaise that has been rocking quality stocks all over the world. This year's Summer Olympics in Beijing were supposed to be a shiny beacon, showing the world how far China has come. But the situation is quickly disintegrating into a blazing Molotov cocktail that will let us know how far it has to go.

The Tibetan unrest. The YouTube ban. The takedown of several indigenous video-sharing sites. The stance to prohibit media companies from broadcasting images of Tiananmen Square during the Olympics.

The more oppressive China is beginning to sound, the grimmer the outlook for Chinese stocks.

The rise and fall of China
Things were going well for China in December when the Nasdaq 100 added not one but two Chinese growth stocks to its popular market gauge. The addition of search-engine leader Baidu.com (Nasdaq: BIDU  ) and display advertising giant Focus Media (Nasdaq: FMCN  ) was seen as validation of China at the time.

So what do the subsequent share-price belly-flops have to say? Baidu opened at less than half its November peak. Focus Media shares were also temporarily trading for less than half their November peak last week. Lucky Focus Media! It's only off by 45% from its high set just four months ago.

If you didn't know any better, you would think that Baidu and Focus Media have fallen apart fundamentally. That couldn't be further from the truth. Both companies actually trounced analyst expectations in their most recent quarter, with last week's report out of Focus Media proving a perfect example of how the right company doing the right things in the wrong place can wear on you.

Focus Media's report was a great one. Earnings lapped Wall Street's profit targets. Its guidance was also buoyant. Shares opened 14% higher on Wednesday, only to see the initial euphoria fade. By the end of the day, Focus Media's stock closed 11% lower than the day before, or a head-scratching 22% off its opening high.

More than a fleecing
It's not just the ill-timed Nasdaq 100 inductees feeling the pain. Sohu.com (Nasdaq: SOHU  ) figured it had hit the jackpot when it became the official site for Olympics coverage within China. However, its stock has shed more than a third of its value since peaking three months ago. Home Inns & Hotels (Nasdaq: HMIN  ) , the fast-growing chain of value-priced lodging, has also seen its stock lose more than half of its value in recent months.

Ctrip.com (Nasdaq: CTRP  ) may be seen as a relative superhero, given that the country's leading online travel portal is off by just 21% since hitting its all-time high three months ago. Smaller yet slower-growing rival eLong (Nasdaq: LONG  ) is now trading for just pocket change more than the $6.24 per American depositary share in cash on its balance sheet.

These were all supposed to be the Olympic Games' darlings. Now it seems as if they've been tripped up during the qualifying rounds.

The risks vs. rewards debate
Value investors would normally be pouncing on the opportunities. Proponents of GARP -- growth at a reasonable price -- should be enamored of the opportunity to snap up companies like Baidu and Focus Media for forward earnings multiples that are a fraction of their growth rates.

Unfortunately, there is something eating into the flavor of a market-stomping Baidu at 37 times next year's profit estimate. There have always been fears of an oppressive China. Whether it's cracking down on the opening of new Internet cafes, hitting up search engines for the identities of critical bloggers, or banning Web entries on the bloody protests at Tiananmen Square, China has never tried to pull the wool over the world's eyes.

The market has shaken off the incidents, cutting the country some slack since a nation of 1.3 billion people is too juicy to ignore this early in its growth cycle. Unfortunately, the current Tibetan uprising comes at the worst possible time. It is reminding the world of the risks inherent in China.

Instead of China's booming economy and appreciating currency giving stateside investors reasons to diversify their portfolios with more Chinese equities, fears of the scene that may escalate as China prepares for the Olympics in a few months have the markets fearing the worst.

I still believe in the growth stocks because earnings continue to grow. However, investors have been applying their own market penalties for the inherent risks. You can't blame them for that.

Let's hope that China's legacy is more golden than tarnished as we head into the Olympics.

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