Investors Beware: These Are the Crazy Things Chinese Companies Can Do

Earlier this month, I took a look at the entire landscape for Singapore-listed shares to find the number of net-net shares that were available as of 31 October 2014.

As a recap, net-net shares are extremely cheap shares on an accounting basis as they carry a market capitalisation that’s lower than their net current asset value (total current assets minus total liabilities). For some perspective, the SPDR STI ETF (SGX: ES3), a proxy for Singapore’s market barometer the Straits Times Index (SGX: ^STI), is valued at a premium of around 30% over its book value.

Back then, when I ran my screen over the Singapore market, I found 107 net-net shares (see the chart below; click for a larger view) amongst the 750 shares which data provider S&P Capital IQ has records of. A closer look at those 107 shares revealed something interesting.

Number of net-net shares in the market (31 October 2014)

Source: S&P Capital IQ

Turns out, there were 34 shares based in China out of that list of 107. In Singapore, those shares are under a broader group known as the S-chips (Singapore-listed companies which are based in China). As of 31 March 2014, approximately 17% of the companies listed in Singapore originated from China – and yet we have almost one-third of the current net-net shares in Singapore being S-chips.

When a company carries such a low valuation as to qualify to be a net-net share, it could mean two things: 1) the share price has been pushed to irrational lows as a result of an extremely pessimistic and unrealistic assessment of the company’s corporate future by market participants; or 2) the market has questions about management’s integrity and fears that there might be some accounting or business-related shenanigans going on.

With the S-chips, it seems likely that it’s the latter scenario at work, rightfully or otherwise. But, who can blame the market? Chinese companies do have a reputation – of the bad kind. My colleague Mike King had recently shared a number of crazy scandals which some Chinese companies have been involved with. Here’re a few:

 “In September this year, Ultrasonic, a shoe company listed on the German stock exchange, announced that its CEO and COO had vanished along with most of the company’s cash. They have since resurfaced in China, admitted to taking some of the money for ‘personal use’ and promised to pay it back. But it seems unlikely that the company will ever see the funds again…

… Two years ago, a major accounting scandal erupted in China. It was discovered that many Chinese companies were keeping two sets of books: one to show their auditors and shareholders, and another revealing the actual numbers. Unsurprisingly, the actual numbers were far less rosy than their public books.

Caterpillar, the US heavy equipment manufacturer had to write off US$580 million off its acquisition of Siwei in early 2013, because the company was found to not have most of the equipment it listed on its books, as well as some serious accounting issues.”

In particular, the issue with Caterpillar caught my eye because investors often see an investment into a Chinese company by a reputable party as justification that there is indeed value in the former. But if even an industrial heavy-weight like Caterpillar can be hoodwinked by a Chinese firm which is involved in similar businesses as itself, investors really need to tread carefully within the S-chips space.

Of course, the market can and does get things wrong – sometimes, an S-chip which has been punished by the market has actually done no wrong and investors who believe in the company can be richly rewarded. But like Mike said, “investors need to be fully aware of the risks.” When it comes to S-chips, buyers beware.

Knowing about the dangers in the share market is important. But there are also other important things to know about in investing. If you'd like to find out more, we at The Motley Fool Singapore have prepared a report titled What Every New Singapore Investor Needs To Know It is a quick five to 10 minutes read on what's really important about the share market and is a great guide for both new and experienced investors alike regarding the basics of the market.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.