Acounting Fraud – A Common Theme
Value investors are constantly sourcing for undervalued companies in every possible way, setting our filters to help us screen out that initial list of companies. I believe many out there would agree that majority of these undervalued gems would come from Asia, Chinese shares in particular, be it A-shares, P-chips or S-chips. However, shares are never undervalued for no apparent reason. These Chinese shares have fallen out of favor given the numerous corporate scandals.
Back in 2006, when China initially opened her doors, S-chips were investor’s darlings, where we see companies like Fibrechem Technologies having a run up in prices. However, such enthusiasm quickly faded as earnings started falling short of estimates. Many have had their fingers burnt when these share prices plummeted when problems such as accounting frauds and defaults started surfacing. Personally, I have witnessed friends having all their money locked in such shares and unable to exit due to the stocks getting suspended.
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With this growing fear that Chinese companies will just disappear when their over inflated sales figures, empty coffers and huge debts comes to light, it is no wonder that there are so many Chinese companies trading at such cheap valuations. Just applying a net-net filter for the Singapore Market, 65.5% of the counters are China companies.
Talking to my colleagues in Shanghai, many have admitted that they too suffered losses in the Chinese stock market due to Chinese companies cooking their books and have ever since stopped investing in the stock market. In my opinion, many have decided to not touch any China related stocks to avoid any possible risks, given the difficulty to differentiate which are the good ones and which are the black sheep.
However, should we value investors just give up on all Chinese stocks and pass up on discovering hidden gems like Sino Grandness? Given how such stocks were able to pass the audit checks of reputable audit firms, many would be thinking, what then can we retail investors do? Talking to auditors from the Big 4, I do believe that it is definitely not easy for us retail investors to spot accounting frauds. However, this does not mean that it is impossible. Over the years, we would notice the trends and similarities in companies that have been suspected and found for corporate frauds.
While I may have presented common themes amongst Chinese companies found of fraud, it is not some hard and fast rule but merely a guideline for us to use when investing. Nonetheless, only invest in companies that you are able to feel comfortable with.
Disclaimer: The author is long T4B.SI