Tips for investing in Chinese stocks: Protection from fraud

Just a very quick post from me today on the risk of investing in Chinese companies. This article, which first appeared on bloomberg, is a great summary of the problems associated with investing in China.

The biggest problem investing in Chinese stocks is the lack of transparency. All the advice that people give about doing research etc. about your companies, and reading the reports carefully and keeping up to date are useless if you are being lied to. Many Chinese companies (as outlined in the article) have had their auditors resign and / or have had to delay releasing their results over disputes with their auditors.

There is no easy solution to this problem. You may want to just avoid investing in China or if, like me, you see real value in some of their sectors and in being present in this growing market then consider doing the following:

• Add a fairly steep discount to your valuations to account for the fact that the results may not be completely truthful


• Always read the auditors report. For companies listed on the ASX, NYSE, Nasdaq etc I rarely bother but in China it is essential to see whether the auditor has given it a clean bill of health. Also check out who the auditor is and make sure they are a large firm with a good reputation


• Try and reconcile company reports on how they are going with the broader Chinese market. If you are investing in a small company try and find big reputable companies that are operating in the same space and see what they say.


• Contact the IR person and get a feel for how believable they are. You may think that as a small investor you will never get a response - but as long as they don't know how much you have to invest they will generally answer your questions...note take these answers with a grain of salt


• Research what other investors are saying - often other investors have actually gone to see the operations of the company you want to invest in. If it is dodgy most will have something to say about it so look for this information

Basically you are trying to find reasons not to invest in the company. If you don't come up with anything substantial then consider going ahead and investing but always keep the risk in the back of your mind and acknowledge that you are getting a higher return for taking a risk that others are perhaps not prepared to take.