Here's an investing riddle: What's bad about a company that's trading for three times earnings and growing those earnings at more than 50% annually?
That may sound Crazy Eddie-cheap, but the problem is that the company in question here isn't actually getting the cash from all of its sales. Instead, it books the revenue, books the earnings, and then books the money it doesn't receive as "accounts receivable" on the cash flow statement.
Before you start an email to the SEC, know that this is all perfectly legal. But rather than get into the accounting details, I'll just point out that it's not all that an attractive situation for investors.
See, a dollar today is worth more than a dollar tomorrow. And in the case of this company, it's generally not seeing the dollars from its sales for 150 days. That's a problem, particularly since this company's customer base may end up paying no dollars at all.
I'll pull back the curtain
The company turns out to be a small Chinese manufacturer of automotive electrical parts called Wonder Auto Technology, which counts big names such as General Motors
That's the rub with accounts receivable. And though the growing long-term demand for cars in emerging markets is promising for Wonder Auto's growth, the company will be cash-flow negative until it can start collecting from its customers. And that ain't good.
Which brings us to ...
Wonder Auto, however, is not the only company struggling with rising accounts receivable in this tough economy. Companies such as ConAgra
And that's the first thing you must know before you buy shares of any company, and particularly shares of a fast-growing foreign company: Who are its customers and how are they doing?
It's a critical question. Take CGG-Veritas, for example. This French company provides seismic data services to multinational energy companies such as ExxonMobil
And while we have no doubts at Motley Fool Global Gains that 2009 will be a lean year for energy industry profits, CGG's customers tend to be cash-rich and focused on the long term. In the end, that should see CGG through to the other side.
But not all companies will be so lucky.
You should also know
The second thing you need to know about fast-growing foreign stocks is the currency or currencies in which they do business as well as the currency in which they report their financial results. While that may not sound like a critical thing to know, recent volatility in the currency markets has wreaked havoc on foreign company profits and balance sheets -- with currency derivative losses even driving Mexican retailer Comerci into filing for bankruptcy protection. Even behemoths such as Novartis
Now, in some cases these are just meaningless paper gains or losses. Many Chinese companies that trade here in the United States, for example, earn all of their revenue and pay all their expenses in RMB (renminbi), the currency of China. Yet when it comes time to report to investors, they have to translate everything into dollars -- and these translations can make growth rates seem faster or slower, so it's important to adjust for them when you're analyzing a company.
American Oriental Bioengineering, for example, advertised 62.3% year-over-year revenue growth for the third quarter of 2008. That, however, was measured in dollars. After you adjust for the exchange rate, top-line growth was just 47.1%.
Both are good, of course, but they're significantly different numbers. Just be aware and prepared.
Accomplish what you aim to accomplish
Finally, before you buy a fast-growing foreign stock, make sure you know why you're doing it. Do you just want exposure to China, for example, or do you actually think the stock you're buying is a good bet? If it's the former and you haven't done the company-specific research, then consider just buying a low-cost exchange-traded fund. You'll get the same macro exposure without the added company and execution risk.
Yet there are significant profits to be had by people who are willing to do that company-specific research. A prominent investor relations expert in China recently told me that while he believes 25% to 30% of U.S.-listed Chinese companies will delist or go bankrupt over the next few years, a handful will earn investors five to 10 times their money.
That's the opportunity that exists today, and as co-advisor of Motley Fool Global Gains, I'm focused on helping more American investors take advantage of it. But you can only do that if you know these fast-growing foreign companies cold.
If you'd like some help doing just that, click here to join us at Global Gains free for 30 days.
owns shares of American Oriental Bioengineering, which is also a Motley Fool Hidden Gems pick. CGG-Veritas and Wonder Auto are Global Gains recommendations. Wal-Mart is an Inside Value selection. The Motley Fool owns shares of American Oriental Bioengineering. Get your Fool's disclosure policy here while it's still hot.