To really understand a stock, you just have to get down and dirty, break out your pencil, and really weigh the risk versus reward potential of the company you're following. I propose we take a closer look at the good and the bad at China Valves Technology (Nasdaq: CVVT) to see if the stock is a good value or a potential money pit.

The good
China Valves Technology originally piqued my curiosity a few months ago because of its incredible growth rate. It makes various types of pressure valves used across numerous industries, particularly petrochemical, oil, and gas. With oil prices rising to new 52-week highs, interest in drilling is also running high, possibly creating greater demand for China Valves' products.

Its valuation also seems compelling compared to its peers in the metal fabrication sector:


Price-to-Earnings (TTM)

Expected Revenue Growth in 2011

Operating Margin (TTM)

China Valves Technology




Watts Water Technology (NYSE: WTS)




Roper Industries (NYSE: ROP)




TTM = trailing 12 months.

These are eye-popping figures which show how remarkably inexpensive the market is pricing China Valves in light of a 24.4% expected growth rate in 2011. In the third quarter, China Valves nearly doubled revenues and grew gross profits by 82% compared to the same quarter a year ago. If it can continue to execute and beat its own expectations, the sky could be the limit.

The bad
The problem with China Valves is the growth which makes it so attractive is also what concerns me. China Valves has been growing predominantly through acquisitions -- including the recent purchase of Yangzhou Rock Valve Lock Technology. Although these purchases are accretive to earnings, Yangzhou's product line has so far resulted in considerably lower margins as rising raw material costs, coupled with significantly more lower-priced product sales, have eaten into margins.

In its most recent filing, China Valves reported gross margins of 45.4% in the third quarter of 2010 compared to 49.3% in the same period last year. This decline is disconcerting and could become a trend worth watching.

Auditor concerns are also in the forefront. Rino International recently came under fire because of questionable accounting practices, and China Valves uses the same auditor. Thus far, nothing has been brought to light to show any abnormalities in China Valves' figures, but investor patience is wearing thin with Chinese equities.

The takeaway
It's no question that China Valves seems cheap by the numbers, the question is whether those numbers can be trusted in light of what we've seen recently from small-cap Chinese companies. If you're a long-term, younger investor who can take the risk, these high-growth, cheap-on-paper plays could make for a nice risk-reward play. If you're nearing retirement, this is probably not the right play for you.

Have an opinion on China Valves Technology? Let's hear about it in the comments section below!

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Fool contributor Sean Williams does not own shares in any companies mentioned in this article. Rest assured, if they made a valve that sucked half the traffic out of Seattle, he'd buy it! You can follow him on CAPS under the screen name TMFUltraLong. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.