When my favorite cashier at Trader Joe's -- a thoughtful and perceptive guy -- starts talking to me about day trading Chinese Internet stocks, it's time to pay attention. I don't day trade -- readers know that I enjoy but carefully limit risk -- but just because you're on a diet doesn't mean you can't look at the menu.
So I listened with fascination about Netease.com (NASDAQ:NTES), and checked it out, plus Sina Corp. (NASDAQ:SINA), Sohu.com (NASDAQ:SOHU), and Chinadotcom (NASDAQ:CHINA).
From a price perspective, it's easy to see what all the fuss is about: Sohu.com is up more than 3000% from its 52-week low. The others range from plus 575% to more than 2800%.
But for business-focused investors at The Motley Fool, while it's possible to understand how these companies make money, it's harder to follow them closely or understand what the stock prices have to do with valuation -- for reasons I'll explain. And that brings to mind the boom in U.S. Internet stocks at the end of the great bull market.
A glance at the latest annual report reveals that Chinadotcom is a Pan-Asian e-business solutions provider incorporated in the Cayman Islands, with most of its revenues from Chinese operations and some from South Korea. As of Mar. 31, 2003, AOL Time Warner (NYSE:AOL) and Hong Kong-based Xinhua each owned around 7% of the company.
Sina Corp., formerly Sina.com, operates portals targeting Chinese users in China, Taiwan, Hong Kong, and North America, including growing online gaming operations. Due to prohibitions on foreign ownership, Sina has only contractual ownership over its Chinese operations. Oh.
I'll stop there for this short take (and beg the indulgence of those -- such as the knowledgeable folks on our China Connection discussion board) -- who know these companies far better). These first steps point to my mission today to highlight the three greatest risks of investing in an emerging market, especially China.
1. A legal system that provides little recourse for owners of property rights and a framework for handling business birth, operation, and death. The Chinese government's economic reforms are breathtaking in scope and speed, but they are relatively young. The government restricts owning Internet content or telecommunications operations in the nation, and it has, can, and will make dramatic changes in these and any other businesses regardless of property rights at any time.
2. The U.S. Securities & Exchange Commission can't be the cop everywhere, but we have almost 70 years of experience regulating the securities markets. This acts as a deterrent. China is not there.
3. Foreign issuers file just once a year, most as close to the deadline of six months from the end of their fiscal year as possible. It is very hard to be current on their businesses. Even companies like Elan Pharmaceuticals (NYSE:ELN), which reports under stringent requirements in Ireland, have proven difficult to follow and are prone to accounting disasters. Sina and Sohu, though China-based, do elect to file 10-Q and 10-K reports; Netease and Chinadotcom do not.
Would any of us love to have earned these returns? Sure, and congratulations if you have! For the rest of you, be very careful. Investing in an emerging market like China today is not informed speculation, but gambling.
