Playing Chinese IPOs: What You Need to Know

Chinese stocks are again the focus of increased attention and speculative trading. In China, the benchmark Shanghai Composite Index (SCI) has been rallying. An area that we continue to see action is in Chinese Initial Public Offerings (IPO). There are so many Chinese penny stocks and micro-cap stocks waiting to cross the ocean in search of U.S. dollars and exposure. But remember that the key to successful stock picking is research.Chinese stocks are again the focus of increased attention and speculative trading. In China, the benchmark Shanghai Composite Index (SCI) has been rallying. It is currently up close to seven percent this year, which is encouraging given that the index lost 14.31% in 2010.

An area that I continue to see action is in Chinese Initial Public Offerings (IPO). There are so many Chinese penny stocks and micro-cap stocks waiting to cross the ocean in search of U.S. dollars and exposure. But remember that the key to successful stock picking is research.

In a report compiled by legal firm Pillsbury, over 30% of the 200 companies interviewed said they would prefer to seek a listing in the U.S. About 45% preferred Hong Kong or China.

We have seen numerous successful Chinese IPOs over the past two quarters.

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In December 2010, Chinese online video superstar Youku.com Inc. (NASDAQ/YOKU), which was subscribed at $12.80, surged to close to $33.44 on its first day of trading, up a staggering 161% in a day! Fast-forward a few months and YOKU is trading at over $44.00, up over 243%. The attraction here is that the company has a 40% penetration rate in China’s massive Internet market in which there are over 420 million consumers. Can you hear the cash register?

Prior to YOKU, there were several new Chinese IPOs that debuted at well above the IPO price and surged. These included Country Style Cooking Restaurant Chain Co., Ltd. (NASDAQ/CCSC), an operator of fast-food eateries. The stock was priced at $16.50, but debuted at $25.00 on September 28 and surged to a high of $36.45, before settling back to the sub-$20.00 level, where the stock may be worth a closer look.

In my view, the buying frenzy is too optimistic. Another example is Chinese online real estate portal SouFun Holdings Ltd. (NASDAQ/SFUN), which debuted at $67.00 on September 17 and surged to nearly $100.00, before initiating a four-for-one stock split on February 18.

The current filings have slowed given the higher market risk.

An interesting company that recently listed is China-based Zuoan Fashion Limited (NYSE/ZA; market cap: $204 million), a seller of casual menswear via a network of 1,075 retail outlets in China. The stock debuted at $7.00 on February 15, and it is currently trading at $7.38. I like the company’s focus on urban males between 20 and 40 years old. But, due to the limited financial information, I’m hesitant and would rather buy on weakness; like at $6.80.

The key to trading Chinese IPOs is to wait for several weeks and watch to see if the stock settles down in a set buying range. Buying on the first day can generate some impressive returns as we saw in Youku.com and Country Style Cooking, but it also makes you vulnerable to profit-taking, especially if you were not one of the lucky clients who did not get in near the IPO price.

The rule of thumb is to be patient, follow the stock, and wait for weakness to buy. China has been around for thousands of years and it’s a country where patience has been a critical trait.