Potential Buying Opportunity:
Chinese Stocks Oversold

Over the last few months, there has been a backlash on small-cap Chinese stocks that has driven down the valuation on some of these stocks to extremely low levels. Why this is happening, and how it could be an opportunity for the investor comfortable with some risk.

Over the last few months, there has been a backlash on small-cap Chinese stocks that has driven down the valuation on some of these stocks to extremely low levels.

When you trade micro-cap stocks or small-cap stocks, there is added risk. And when you trade Chinese small-cap stocks, there is even more risk.

The increased focus on the safety and factuality of Chinese reverse mergers by the Securities and Exchange Commission along with stock exchanges has hurt many of the small-cap Chinese stocks listed in the U.S. There is a move to create a special market for reverse merger stocks in the works, where stocks would trade prior to listing on the Pink Sheets.

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The speculation is that numerous small-cap Chinese stocks debuting on the domestic exchanges, which came to form via reverse mergers, are currently being investigated for pump-and-dump schemes and with questionable reporting practices on their statements.

Reverse mergers occur when a private company that wants to go public finds a shell company that is trading and buys the shell. The private company then transfers its assets into the empty shell and, after some minor reporting, the company becomes public.

The advantage is that it is much easier to take over a shell company than to try to get listed via the traditional method. The reporting requirements are much less stringent in a reverse merger. This appears to have attracted numerous Chinese companies.

I’m not saying that all of these Chinese reverse mergers should be the subject of investigation, but since this strategy is the easiest method of listing on domestic exchanges, I’m not surprised to hear of the wrongdoings in this area.

There appears to be a witch hunt for these small Chinese companies, many of which are likely legit. Yet, we are seeing short sellers, bloggers, and anyone with access to the Web posting negative reports on small Chinese companies.

As a result, there has been unwarranted selling in many legit Chinese stocks to the point where the valuations are ridiculously attractive.

For instance, Deer Consumer Products, Inc. (NASDAQ/DEER) plummeted nearly 30% on March 21 on allegations in a stock blog by a short seller. It went down to $6.57 on April 6. Deer subsequently rallied to $10.40 on May 4, up 58% in a month.

I’m not saying all of these Chinese reverse merger stocks are legit, but there are and will be opportunities to make quick money, as in the case of Deer.

I have covered many of these stocks based on what I believe were factual results and information. You cannot always differentiate the good information from bad. When a sole short seller attacks a company, you have to take a step back and wonder.

The way I see it is be careful here. There are some suspicious companies, but I feel that the majority of Chinese companies are legit, even those that formed via reverse mergers.