Before we get started, you should know that I believe China will be the global economic success story of the next 25 years. That said, the rally across Chinese stocks this past year is overdone.
Just as they were before they came crashing down at the end of 2007, Chinese stocks are generally priced today as though there won't be significant volatility in the country's growth story. There will be, and many stocks have been dropping of late on the news that China is increasing the reserve requirement for banks.
Remember, this is a country that's still transitioning from a command-and-control economy, one that doesn't guarantee property rights, and one that doesn't yet have 100% trustworthy accounting regulations or enforcement mechanisms.
Yet the Chinese stocks that trade on our U.S. exchanges today are selling for more than 20 times earnings! If I'm going to pay that for a stock, I at least want the guarantee that I own it.
You don't necessarily get that in China
Many investors love risk right now. They're chasing hot returns in the hopes of making up for the losses of 2007 and 2008. That's not a viable long-term investment strategy. In fact, it will only end in disappointment.
So it goes for those suckers. The good news for the rest of us is that we can take advantage of their exuberance to make money. It's with that opportunity in mind that I present to you two China stocks you may consider shorting.
Short idea No. 1: SkyPeople Fruit Juice
On its face, SkyPeople Fruit Juice
But as our Global Gains research team looked into this stock, we found a few issues that made us question its recent upward momentum. First, there's the fact that the CEO of Skypeople, the AMEX-listed company, is Yongke Xue, who does not own any shares of Skypeople. The CEO of the company's main operating subsidiary, however, is Yongke's brother Hongke, who owns 67% of Skypeople through his holding company Fancylight.
Why isn't the CEO of the operating company the CEO of the shell? I don't know, but in the case of China Biologic Products
Second, SkyPeople seems to have played a little fast and loose with company capital. At one point the company extended an interest-free $43 million loan to an investment company chaired by the same person who chairs Skypeople. That investment company then used that cash to buy Huludao Wonder Fruit, which it then sold back to Skypeople in exchange for loan forgiveness.
Then, according to the company's 10-K, it "erroneously paid monies to its former shareholders as the result of a dividend declaration in February 2008. The monies were then returned to the Company. Because the recipients of the money were no longer shareholders ... the transaction has been treated for accounting purposes as an interest-free loan." This, the company discloses, is a potential SEC violation.
Combine this sloppiness with a business that is more focused on exporting concentrate than serving China's domestic market, and I believe the stock's recent rise is overdone.
Short idea No. 2: BYD
Before you say it, yes, I know it's not the conventional move to bet opposite Warren Buffett and Charlie Munger. But while BYD is the same great company it was when Berkshire announced its original $230 million investment, the valuation is now ridiculous.
How much would a 10% stake now cost you? A cool $1.7 billion, or 27 times EBITDA!
At the end of the day, BYD is a good company. It's run a good battery business over the years, competing with Panasonic
Wait a minute
Now that I've given you two solid short ideas, remember what I said at the top: China will be the global economic success story of the next 25 years. That means you want to be invested there for the long term.
And while Chinese stocks are generally expensive today, we've found a few significant pockets of opportunity for our members at Motley Fool Global Gains. To find out what they are, click here to join us as a Global Gains guest free for 30 days.
This article was first published Nov. 13, 2009. It has been updated.
Tim Hanson is co-advisor of Global Gains. He owns shares of Berkshire Hathaway. Berkshire Hathaway and Coca-Cola are Motley Fool Inside Value selections. Berkshire Hathaway is a Stock Advisor pick. Coca-Cola and PepsiCo are Income Investor recommendations. The Fool owns shares of Berkshire Hathaway. The Fool's disclosure policy tries and it tries and it tries.