Why the Trend Is Your Friend

by Mitchell Clark, B. Comm.

The stock market still wants to rally, but the strongest group in the marketplace now is Chinese stocks. I think both domestic and U.S.-listed Chinese stocks will be one of the best wealth-creating groups available to speculative investors over the next few quarters. And, by speculative, I mean highly speculative. Despite all the fuss, economics in China is still a bit of Wild West adventure and, as an investor, you have to be prepared for any eventuality. One small change in government policy in China can make or break a business. But, while knowing the risks, the fact of the matter is no other large country can offer the same kind of growth that China does.

I’m becoming much more bullish on Chinese stocks right now, because it isn’t just large-cap companies that are moving higher in price. Small- and micro-cap companies are moving just as strong.

Last year, I wrote in this column about a very interesting Chinese company called China Fire & Security Group, Inc. (NASDAQ/CFSG). Like many Chinese companies, this company is growing both organically and by acquisition, and it’s doing so in what is now a growth industry.

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China Fire & Security operates through its wholly owned subsidiaries, Sureland Industrial Fire Safety Limited and Sureland Industrial Fire Equipment (Beijing) Limited. These companies design and manufacture a variety of fire safety products for the industrial market in China. Headquartered in Beijing, with over 30 sales and project offices throughout China, the company’s Sureland division markets its industrial fire safety products primarily to large companies in the iron, steel, power and petrochemical industries in China. China Fire & Security’s business plan is to expand its customer base to the transportation, wine and tobacco, shipping, nuclear energy, and government markets. Currently, the company has some 500 employees and has 52 issued patents covering fire detection, system control, and fire-extinguishing technologies.

In its fourth quarter of 2008, China Fire & Security’s revenues grew an impressive 49% to 21.0 million dollars, up from revenues of 14.1 million dollars generated in the same quarter in 2007. Gross margin increased to 54% from 52.9%, based on more sales of the company’s proprietary products, which are more profitable. Net income in the latest quarter was 6.8 million dollars, representing growth of 69% over net income of 2.8 million dollars generated in the fourth quarter of 2007. On an earnings per share basis, net income grew 73%.

For all of 2008, China Fire & Security’s revenues grew 48% to 69.1 million dollars, up from 46.8 million dollars in 2007. Gross margin for 2008 grew to 57.2%, up from 54.9% generated in 2007. Net income for the year grew 47% to 24.7 million dollars, as compared to net income of 16.8 million dollars generated in 2007. This is an exceptional level of profitability for sales of this level. The company finished the year without debt and with approximately 27.0 million dollars in cash.

As evidence of the significant renewed interest in U.S.-listed Chinese stocks, China Fire & Security recently moved sharply higher in price on the stock market in anticipation of first-quarter numbers, which are due out shortly.

Right now, I’m seeing both large- and small-cap Chinese stocks moving significantly higher in value on global stock markets. And China Fire & Security is a stellar example of this. This trend is going to continue and it will be a source of significant wealth creation on a short-term basis. The party might always end abruptly, but, in this case, the trend is your friend.