Make no mistake: China is still filled with emerging-market opportunities. The economy may still be slowing (January was a particularly slow month for the nation), but the import and export trends show new strength, and the number of stable companies open to investment remains high.
Unfortunately, traditional Chinese investment problems persist -- notably, the unreliability of Chinese data. From big indexes to newbie IPOs, falsified statements make China tricky to rely on, particularly for the bullish seeking strong emerging-market stocks. And while the country's National Bureau of Statistics has yet again promised that it will truly root out falsified data this year, if any changes are made, they're likely to be slow in coming. For the foreseeable future, Chinese stocks still require serious research and not only a second opinion, but several opinions.
Continue to take the following stats with a heap of salt.
1. Asset and account value
Asset fraud is one of the most well-known entrants in the "worst Chinese stats" contest, thanks to the work of investment research companies like Muddy Waters Research. Muddy Waters' latest target, by the way, is NQ Mobile (NYSE:NQ), which may have some seriously inflated values on its books. Muddy Waters' research showed that daily sales outstanding took an average of 145 to 167 days to collect in 2013 -- a potential sign that fraudulent sales are being recorded as accounts receivable. The company also reclassified assets in ways that made them more difficult to value. In response, NQ noted that collection methods and time frames in the China telecom industry differ from American methods and that Chinese accounting practices, not fraud, were responsible for the data.
In the case of NQ Mobile, the effects were immediately apparent: When Muddy Waters made its claim, NQ stock dropped from about $25 to less than $9 in a week. The stock is back above $19 thanks in large part to a new partnership with Sprint. Such deals are expected to continue benefiting NQ in the future. In late February, another global distribution deal, this time with Samsung, helped maintain the stock's recovery. Such alliances with more trustworthy companies often help Chinese companies prevent fallout over fraud charges.
But while fraud has subsided, it hasn't disappeared. Take the case of Wanfu Biotech, which drastically inflated its values prior to its IPO, ultimately leading to the arrest of its chairman in 2013. Faking the value of raw materials, inventory, and equipment is still far too easy in the Asia-Pacific environment.
Assets were not the only thing Wanfu faked last year: The company also posted far higher profits than it actually earned. Similar motives applied, as the company was angling for investor attention. Other reasons for its profit fraud are a bit more personal. According to Chinese news outlets like the 21st Century Business Herald, some Chinese entrepreneurs fake profits to get into the lists of China's wealthiest, which aids their investment efforts.
3. Budgets and costs
Projected, and even current, budgets for big projects also fall into unfortunately gray areas. To be fair, this is a problem shared by many emerging-market companies faced with expansion and new opportunities. But there's a difference between naivete and almost criminally poor accounting. Take CITIC Pacific, the Hong Kong company primarily owned by Beijing's Citic Group, and its infamous Sino Iron project in Australia, which has cost $8.5 billion to date compared to the original budget of $2.6 billion.
Meanwhile, Sinosteel's own $2.5 billion Australian project was put on hold in 2013 for similar reasons. Spectacular budget blunders like these can hammer companies' stocks.
4. National GDP growth
Eyebrows were raised when China reported 7.5% quarterly growth back in August, as this number was precisely what the five-year plan had called for. This was only slightly suspicious -- but good for the Shanghai Composite Index -- until the exact same thing happened in the fourth quarter of 2013, leading The Wall Street Journal and others to report more realistic numbers instead. Not only does this wreak havoc on the Indexes, but it also discourages future foreign direct investment.
5. Provincial GDP
The Chinese provinces are responsible for reporting their own GDP and similar figures. However, provincial officials are judged based on how well their provinces do, so they put a great amount of pressure on local companies to increase their reported production and earnings. Late 2013 saw the latest culprit in the Yunnan Province, where data was sent back to companies if it wasn't high enough, making sure the reported output was about 150% higher than original estimates.
6. Environmental degradation
Pollution rates have stirred plenty of concern regarding China's urban areas and the level of production without oversight. But the government still finds it difficult to calculate. 2013 reports estimated that 2010 environmental degradation cost around $230 billion, but China is just starting to take into account key factors like health costs resulting from pollution. Their numbers are far from encompassing all environmental problems.
In summary, China remains a great place to invest, and the current slowdown gives the bears time to find the most dependable stocks in Asia's fast-paced markets. However, when examining key indicators, don't take numbers like these as gospel. It's still hard to see the other side of the scale.