Growth and Shareholder Dilution

In the China Small Caps space we find very many companies that grow net income by 30% and more year-over-year, so we can safely categorize them as 'Growth Stocks' by definition. However, it isn't actually net income growth that matters for valuation, it is EPS growth -- and here the picture can look quite different if we go into detail. Shareholder dilution is a common problem amongst US-listed Chinese stocks and while I do fully understand the need to raise money to fund growth, we have to look if the significant increase of the share count does actually translate into EPS growth for shareholders.

Let's have a look at seven randomly selected names in the China space, seven stocks that cover a variety of industries. All are traded on senior US exchanges.

Net Income Growth

Ticker	Company	Net 2008	Net 2009	Growth	Net 2010*	Growth*
CAGC	China Agritech	8,641,741	15,584,056	80.33%	23,500,000	50.80%
CCME	China MediaExpress	26,367,000	41,711,000	58.19%	73,000,000	75.01%
CELM	China El. Motor	8,015,892	11,497,698	43.44%	18,450,000	60.47%
CNET	ChinaNet Online	2,800,000	8,444,000	201.50%	14,100,000	66.98%
DEER	Deer Consumer Prod.	3,356,784	12,369,062	268.48%	26,000,000	110.20%
ONP	Orient Paper	8,774,415	12,720,208	44.97%	18,000,000	41.51%
YONG	Yongye Int'l	11,191,779	26,205,453	134.15%	43,500,000	66.00%

(2010 Net Income based on the midpoint of official company guidance)

All seven stocks posted stellar numbers for 2009 with net income growth between 43% and 268%. 2010 guidance is also very positive for all seven companies. Now we should have a look at how the share count (fully diluted) has increased from January 2009 until today.

Shares Outstanding / Dilution

Ticker	Company	O/S 2008	O/S 2009	O/S 2010*	Dilution 2010	Dilution*
CAGC	China Agritech	12,349,808	14,228,943	18,909,219	32.89%	53.11%
CCME	China MediaExpress	20,915,000	22,998,138	33,499,826	45.66%	60.17%
CELM	China El. Motor	10,679,260	12,356,530	21,244,743	71.93%	98.93%
CNET	ChinaNet Online	13,790,800	14,825,125	21,059,683	42.05%	52.71%
DEER	Deer Consumer Prod.	16,985,460	23,190,286	33,767,212	45.61%	98.80%
ONP	Orient Paper	10,769,896	12,232,878	18,336,566	49.90%	70.26%
YONG	Yongye Int'l	20,106,433	31,324,830	44,696,427	42.69%	122.30%

(shares outstanding 2010 based on Q1/10 10-Q filing)

Whoops! And the 2010 numbers are based on the May filings, there are still seven months to go for increasing the share count even more. Now let's look at the income numbers again, but this time we'll measure growth on Earnings per Share:

EPS Growth

Ticker	Company	EPS 2008	EPS 2009	Growth	EPS 2010*	Growth*
CAGC	China Agritech	$0.70	$1.10	56.52%	$1.24	13.47%
CCME	China MediaExpress	$1.26	$1.81	43.86%	$2.18	20.15%
CELM	China El. Motor	$0.75	$0.93	23.97%	$0.87	-6.67%
CNET	ChinaNet Online	$0.20	$0.57	180.53%	$0.67	17.55%
DEER	Deer Consumer Prod.	$0.20	$0.53	169.68%	$0.77	44.36%
ONP	Orient Paper	$0.81	$1.04	27.63%	$0.98	-5.60%
YONG	Yongye Int'l	$0.56	$0.84	50.29%	$0.97	16.34%

(2010 Net Income based on the midpoint of official company guidance)

Already looks a little less exciting, doesn't it? Here are the 2010 numbers next to another in one table:

2010 Growth

Ticker	Company	Shares	Net Income	EPS
CAGC	China Agritech	32.89%	50.80%	13.47%
CCME	China MediaExpress	45.66%	75.01%	20.15%
CELM	China El. Motor	71.93%	60.47%	-6.67%
CNET	ChinaNet Online	42.05%	66.98%	17.55%
DEER	Deer Consumer Prod.	45.61%	110.20%	44.36%
ONP	Orient Paper	49.90%	41.51%	-5.60%
YONG	Yongye Int'l	42.69%	66.00%	16.34%

Based on official company guidance and current share count as of May 2010 (assumed there will be no further dilution this year), all seven companies will grow net income by more than 40% but only one of them will be able to grow EPS by more than 40%. Two of the selected companies will likely end the year with negative EPS growth, while the remaining four should post rather unimpressive EPS growth between 13% and 20% for 2010.

For your investment decisions you should always look at projected EPS growth as well. Most companies will not give EPS guidance - instead they project high net income growth only and leave it to the investor to bring those numbers back down to earth. You should always think about possible shareholder dilution when a company doesn't provide EPS guidance, especially in the China Small Caps space.

This post doesn't mean the named companies would not be undervalued here, in fact most of them trade at very low multiples, and with market sentiment for Chinese stocks having lots of room to improve it is more likely that all seven stocks will trade significantly higher later this year, despite all the dilution. But if you need a reason for why the stock prices seem so depressed in selected emerging market names, always look into EPS growth first

Russell Methodology Changes - Heavy Implications for China Small Caps

A couple of weeks ago I posted a preview for the upcoming reconstitution of the Russell 2000 Index and the possible implications for U.S.-listed China Small Caps. New developments have made basically all the assumptions in that article outdated as Russell made several adjustments to their methodology which will make most China stocks no longer eligible for inclusion in the U.S. Indexes.

Russell is implementing a new rule to determine country assignment for their U.S. and Global Indexes. A "U.S. Company" is no longer just defined by country of incorporation and most liquid exchange, therefore not each China Small Cap which is incorporated in the U.S. and traded on a senior exchange will be automatically eligible for the Russell 2000 anymore. Instead Russell will introduce three so-called "Home Country Indicators":

• Country of Incorporation
• Country of Headquarters (address of principal executive offices)
• Most Liquid Exchange (by 2 year average daily dollar trading volume)

Companies which are incorporated, headquartered, and trade in the U.S. are eligible for the Russell 2000 Index if they meet all the other requirements (minimum float etc.) and make the market capitalization cut on May 28. If any of the three Home Country Indicators do not match, the primary location of assets will be used to determine eligibility. If the primary location of assets matches one of the three Home Country Indicators, the company is assigned to that country. Should the location of assets be inconclusive, Russell will use the primary location of revenues. If that is inconclusive as well, Country of Headquarters will be used as the final determination. All companies that are not assigned to the U.S. by those Home Country Indicators will no longer be eligible for the U.S. Indexes and instead be added to the Russell Global ex-U.S. Index.

Historically, asset owners have diversified their risk by assigning assets to specific countries. Some companies incorporate in a specific country for tax reasons while some chose a higher tax structure for the trade-off of access to capital. Therefore, to most closely track country risk, Russell uses objective criteria to assign countries to the U.S. equity market. All companies which Russell determines to be part of the U.S. equity market are included in the Russell U.S. indexes. Those determined to be non-U.S., using the same criteria, become members of the Russell Global ex-U.S. Index.

Further reading:
Russell U.S. Index Construction & Methodology (PDF)
Identifying "Country of Risk" in the Wave of Globalization

I have updated the Russell 2000 - Reconstitution Screen for China Small Caps to show both Country of Incorporation and Country of Headquarters for all U.S.-listed Chinese stocks that we are tracking. Only 2 out of the 29 stocks that are currently included in the Russell 2000 Index are both incorporated and headquartered in the U.S., and as most (if not all) of those names have most of their assets and derive most of their revenues in China, it is very likely that those other stocks will no longer be eligible for the 2010 U.S. Indexes. The two stocks that still meet all criteria are HQ Sustainable Maritime (HQS) and Advanced Battery Technology (ABAT), where HQS's market capitalization is currently down to $73 million which makes it unlikely that the stock will be above the May 28 threshold.

There are six more China Small Caps which are incorporated, headquartered, and trade in the U.S. and would be eligible for the Russell 2000 to the best of my knowledge: Aoxing Pharmaceuticals (AXN), China Advanced Construction Materials (CADC), China Armco Metals (CNAM), China Direct Industries (CDII), China North East Petroleum (NEP) and L & L Energy (LLEN). LLEN should safely meet the requirements for minimum market capitalization, NEP and AXN both have a good chance to make the cut as well. The other three are currently valued with less than $60 million and most likely will not be within the 3000 largest U.S. companies at the end of this month.

What does this mean for trading China Small Caps in June? Russell will rank all the eligible stocks by their total equity capitalization as of May 28, which means we have one week of trading left. Preliminary additions and deletions to the Russell Indexes are published on June 11 after the market close. We might see additional weakness in stocks that are likely to be deleted from the index throughout June, with huge volatility and massive volume on June 28, the reconstitution day.

Many of the stocks likely to be deleted are financially sound with high growth projections for the next couple of years. There is no other option for portfolio managers tracking the Russell 2000 index than selling those names into the June 28 deadline, and seemingly irrational drops in stock price will likely present excellent buying opportunities as trading in those deleted names does usually normalize very quickly after the reconstitution day. Some tickers to watch are CAAS, CGA, CHBT, CPBY, CPSL, FEED, FSIN, HOGS, HRBN, NIV, UTA and WATG.

It might be rewarding to speculate on a Russell 2000 addition of LLEN, NEP and AXN, but I can't give any guarantee that this is actually going to happen. The new rules will be executed for the first time this year and we do not know yet how those names - who are no different in asset/revenue location than the others - will be treated by the Russell managers.

Trouble Ahead for Chinese Real Estate and Construction Companies

Over the past two decades, China's economic boom has created a new and fast growing upper middle class, people who made a lot of money in the private sector and can now be considered "wealthy" even by Western standards. For those wealthy Chinese there are very few options to put their money to work. Government laws forbid Chinese citizens from making investments in overseas stock markets, and generally there are many obstacles to pass before Chinese capital can leave the country. That leaves only domestic stock and property markets as an investment option.

If you have ever wondered why average price-to-earnings ratios on Chinese domestic markets are so much higher than in Europe or the U.S., there you have the reason. China's leading market, the Shanghai Stock Exchange, might look to be in a downturn now, but don't forget that the SSE Index is still up 50% since the beginning of 2009 and 130% since 2006. Adding to this rally is also that Chinese investors can usually only benefit from rising share prices, so the incentive to buy and hold is very high.

The peak of the stock market craze was reached last November when the Shenzen Exchange opened their "ChiNext" labeled Growth Enterprise Market for high-tech startups. On the first day of trading all of the 28 stocks listed on the new exchange skyrocketed by at least 76%. On average stocks more than doubled with gains up to 210%, just on the board's first day of trading.

According to the official Shenzen website the average P/E ratio of ChiNext listed companies still is a staggering 61.78, and both the board for small and medium caps (P/E: 42.29) and large caps (P/E: 33.53) sports much higher multiples than comparable American or European markets.

The domestic property markets are inflated as well, and for the same reason. Christina Larson wrote a very good article about the subject on the Foreign Policy Blog last week, which describes how Chinese real estate investors are thinking:

Ms. Wang, the wife of a successful Beijing businessman who gave only her surname, has purchased four homes in recent years. There's the apartment she and her husband live in, and three others they hold as investments. All three are vacant; she's making no attempt to rent them out. No property taxes are assessed in China, and so there's no financial penalty for simply buying and holding. The rental market in Beijing, in comparison to the red-hot real estate market, is fairly weak, and besides, renting out those apartments -- putting them to use and risking some wear and tear -- could diminish their value. So they remain pristine and empty.

Commercial property developers have made good money of this thinking, however they are fully aware of the "bubble environment" as Zhang Xin, CEO of Beijing's largest developer SOHO, confirmed in a recent interview with China International Business:

The real estate business should really be looking at rental yield; build a building and then lease it out with the rent giving a decent return. But, because of where China is with asset bubbles, people want to buy the assets regardless of whether they can be leased out or not. Now, if you look at the prices for the property being sold versus the rent you collect there is a real disconnect. Prices are too high, rent is too low, so if you hold property in order to get yield you are likely to get very little. For us it makes no sense to hold property, so our strategy is to sell everything. We see ourselves very much as a manufacturer. We buy land, we build, and then we sell.

Now this strategy to sell property into an inflated market does only work for as long as it stays a seller's market and this is about to change. Mid-April the government introduced new policies targeting excessive speculation in housing investment, mostly in Tier 1 cities like Beijing and Shanghai. For third-home buyers or anyone who already owns more than three apartments, down payments and mortgage rates will increase dramatically. In cities where housing prices are excessively high, or are increasing quickly, or where the supply is limited, banks can choose to reject mortgage applications. Furthermore, the new policies make it much harder for non-local resident buyers to access the market and even a trial property tax is being considered in the four largest cities.

Analysts and media were focusing on those Tier 1 cities and the fast growing cities in China's heartland were widely seen as less affected by the new policies. Brean Murray published a research note just 10 days ago defending Tier 2 developers like Xinyuan Real Estate (XIN) and China Housing & Land (CHLN):

Recent tightening policies targeting Tier 1 cities and third-time home buyers should have limited impact on Xinyuan Real Estate and China Housing and Land, given that first-time home buyers and first-time home upgraders now account for more than 90% of total sales for both companies. Mortgage rate and down payment requirement policies are being kept the same for the first-time home buyers, and are still very encouraging for first-time home upgraders. Both companies also have very limited non-local buyers who are also restricted from housing speculation.

However, last week's quarterly reports have proven Brean Murray wrong. There are clear signs of trouble for real estate developers throughout China and the new policies do very well affect the housing markets in Tier 2 cities. Xinyuan added very troubling comments to their report last week:

While we do not operate in Tier I cities where speculation has been most rampant and the policies are most targeted, the new policies have nonetheless had an impact on our projects, most notably in our Kunshan project. Kunshan appears to be the Xinyuan project most affected where virtually no mortgage lending is taking place. 182 apartment units were sold in the first 18 days of April while just 8 units were sold in the subsequent 10 days. Potential apartment buyers are also seeking clarification of the new housing policy. While we continue to believe the attractiveness of the project due to its nice location, easy transportation to Shanghai and more affordable price, we do not know when buyer traffic will return and with what force under the new housing policies since the new policies have only been implemented by a couple of weeks. As the Kunshan project accounted for 63% of our contract sales in the first quarter of 2010, it is difficult for us to predict the sales trend for May and June.

China Housing & Land has been somewhat more positive when they commented that "since government policies raised purchase hesitation in the Xi'an real estate market, the sales for the coming months have become less visible. That said, we are still confident with our project pipeline and market positioning and maintain our previous financial outlook for 2010."

It will be very interesting to see how the Chinese government will proceed from here. It seems clear that they are determined to curb speculation and possibly bring down the inflated market to a more tolerable level in an orderly way. However, construction and property markets are the main drivers for China's growth and there is a high incentive for officials to just do business as usual for as long as possible. Many local governments derive as much as one third of their annual revenues from land sales, and without that money some of the spending for desperately needed infrastructure projects might have to be cut.

As a private investor in US-listed Chinese equities you should be aware of this situation. Even assumed that the government will be able to deflate the property markets in an orderly way, even if you believe that there is no bubble to burst and China will be able to maintain annual GDP growth rates of 8-10% over the long term, some industries will most likely be affected by the new policies and the effects might be more serious than just stalling growth rates.

I would personally avoid those industries for long-term investments now, most notably real estate, construction and steel. Even if many of the stocks in those sectors might look cheap now based on trailing earnings, there is a growing uncertainty about future prospects, and if you put your money in "safe" sectors that are only marginally affected by those developments you will have a much better risk/reward ratio.

Excellent Buying Opportunities

Last week we saw a broad sell-off in US-listed Chinese companies with the average stock as measured by the Emerging Chinese Small Caps Index dropping about 15%. While OTC-listed stocks were holding up relatively well - our China OTC Index is about flat for the year - we saw the biggest declines in Chinese stocks listed on senior exchanges. Our China Main Index is down a staggering 13.3% year-to-date and closed Friday at new year lows. I believe value investors should now focus on those bigger names in the China small caps space as the depressed price of many of those stocks presents excellent buying opportunities, both for swing traders looking for a bounce and long-term growth-oriented investors who can now gobble up quality stocks at a fraction of their former valuations.

Even if Chanos, Faber and Rogoff are right about an inflated Chinese real estate market and a more or less imminent correction there, many of the US-listed Chinese names should continue to show impressive results and deliver on their promise of high growth in the quarters and years to come. Before I will present you a few ideas, let's have a more detailed look at last week's damage. I will focus solely on Nasdaq, NYSE and Amex stocks in this article, but you will find many more stocks on the OTC.

Stocks that printed a new 2010 low on May 6 or May 7: ABAT, ADY, AMCF, AOB, APWR, BEST, CADC, CAGC, CALI, CBAK, CEU, CGA, CHGS, CHLN, CMFO, CMM, CNTF, COGO, CPSL, CREG, CRIC, CRTP, CSKI, CSR, CTC, CVVT, CWS, CXDC, DEER, DGW, DHRM, FEED, FUQI, GFRE, GRRF, GSI, GU, HOGS, HPJ, HQS, JRJC, NEP, NKBP, ORS, RCON, RINO, SIHI, SKBI, SORL, SUTR, TPI, TRIT, TSTC, TXIC, UTA, VISN, WATG, WH, WUHN, XIN, YONG, ZSTN

Stocks that have retreated 50% or more from their 2010 highs: AMCF, APWR, AUTC, CADC, CAGC, CALI, CBAK, CDII, CEU, CGA, CHGS, CHIO, CHLN, CJJDD, CMM, CNAM, CNET, CNTF, CREG, CSKI, CSR, CWS, DGW, FUQI, GFRE, GRRF, HPJ, KNDI, NEP, ONP, ORS, RINO, SBAY, SCOK, SIHI, SUTR, TBV, TPI, TRIT, TSTC, TXIC, VISN, WATG, WUHN, ZSTN

You can sort through more detailed numbers on our new performance screen.

Now let's have a look at some individual stocks. We want to avoid unnecessary risks now with so many stocks trading at depressed levels, so we will ignore the following sectors that are related to a possible real estate "bubble" and look more vulnerable to more tightening measures by the Chinese government: construction, steel, finance, real estate, exporters and utilities.

China Armco Metals (CNAM)

The stock is down 59% from its March 5 high at $11.10 and trading 30% below the level of its recent equity offering at $6.50. The development of Armco's business is extremely positive and the company guided for net income to exceed $12 million in FY 2010 which translates into 2010e EPS of about $0.85 with all signs pointing at sustainable strong growth in the years ahead. The stock is trading at a P/E of 5 and offers a tremendous buying opportunity at current levels.

Skystar Bio-Pharmaceutical (SKBI)

Skystar lost more than 30% from its January high at $12 and is trading in the low $8 range at the time of writing. The stock price is depressed for a long time already as the company has announced to reorganize their business to include a new product segment, resulting in low growth rates for 2010. But what investors tend to forget is that SKBI's business should take off in FY 2011 and that is not so far ahead as it seems. Rodman & Renshaw's quite ambitious expectations call for SKBI to earn $2.51 per share in 2011 which would mean you can buy the stock now for just roughly 3x 2011 earnings.

SinoHub (SIHI)

Their new contract manufacturing business for mobile phones seems to be taking off now. The company expects to reach full capacity utilization by June and guided for 40% revenue growth in 2010. SIHI reported EPS of $0.48 for 2009 which gives it a trailing P/E of 5 at current levels. The stock is currently trading at 2008 levels and with 20% EPS growth in 2009 and projected 40% revenue growth in 2010 this seems plain silly. The one analyst I know of, Canaccord Adams, has a $6 price target on the stock.

Rino International (RINO)
Tri-Tech Holding (TRIT)

I have talked about both these water companies a lot already, yet their stock prices keep falling. RINO and TRIT are now trading 59% and 57% below their 2010 highs, respectively, and valuation is down to 7-8x 2010 earnings. Yet both companies are very well positioned to benefit from the massive government programs dealing with two of the most dramatic problems China is facing today: pollution and urbanization. Three analysts are covering RINO with Buy ratings and targets between $34 and $40. Piper Jaffray initiated coverage on TRIT in late April with a price target of $20.

ZST Digital Networks (ZSTN)

ZSTN has been beaten down with the whole telecommunications sector (TSTC, GRRF), but I believe this is not at all justified. Analysts (Rodman & Renshaw) are calling for 2010e EPS of $1.20 and 2011e EPS of $1.52, but it seems the market is not believing them or the company's own guidance as the stock is currently trading below $6. ZSTN is expected to report Q1/10 earnings on May 13 and the first quarter is usually the weakest due to the Chinese New Year holidays and other factors. If you are risk avoidant you want to buy this after earnings have been released and the company reaffirmed its 2010 guidance for net income between $13 million and $15 million.

Overall the China Small Caps sector provides many excellent buying opportunities here. There is of course no guarantee that the current correction in the general markets and especially in more risky US-listed emerging market stocks will not continue next week, but as a value investor you might find yourself thrilled with being able to buy high growth stocks at such low valuations now already. Greece and Portugal, the European currency, the Chinese real estate markets and a possible revaluation of the Yuan have little or no impact on those companies' growth prospects. If you don't believe in doomsday scenarios like a double-dip recession triggered by a breakdown of the Euro or a massive crash in China, then you shouldn't be afraid of putting some money to work here.

Most of the companies mentioned here will report Q1/2010 earnings over the next two weeks and in many industries the first quarter will be impacted by seasonal effects like cold weather and the Chinese New Year break. You might want to wait until the companies you are watching have reported their numbers, but given the current valuations you might find yourself buying in at a much higher level then.

China Model Portfolio Additions

As previously announced I am adding several new positions to the China Model Portfolio today.

China Armco Metals (CNAM)

Those who follow the model portfolio will remember this stock. We sold it in early March at $9.60 for a 185.71% gain. Now the stock is back down to a level where it is a clear long-term buy again. One month ago the company has issued very bullish guidance for "revenues for the full year of 2010 exceeding $220 million with net income exceeding $12 million." The recent $10 million private placement put enormous pressure on the stock but even if we anticipate full conversion of the issued warrants the company has only 15.68 million shares outstanding and my EPS projection for 2010 is still at $0.85 on a fully diluted basis. And CNAM is currently trading well below the recent offering price of $6.50.

I am buying 1000 shares of CNAM at Friday's close of $5.48 with a 6-9 months target of 12x 2010e EPS or $10.20.

I am adding three more positions to the China Model Portfolio based on the Russell 2000 - Reconstitution Screen for China Small Caps. The time frame for those is 1-3 months with weekly re-evaluation. I consider all three stocks undervalued at current levels with big potential upside on a positive Russell 2000 addition announcement on June 12. There is further downside risk for the general markets at the moment, and those stocks might retreat further in the coming days, but I can not make changes to the portfolio during the week and wait for a possibly more ideal entry. However, I consider all of those worth the risk here, especially as a Russell 2000 speculation but also on a fundamental, value investing approach.

China Recycling Energy (CREG)

Another former portfolio position that we sold for a nice profit. The stock reached its all-time high on March 24 with $6.16 and we can buy it now for 3 dollars less with an unchanged positive business outlook. I am buying 1000 shares at Friday's close of $3.16 with a 1-3 months target of $5.50.

China Yida Holding (CNYD)

This stock held up relatively well and it has fantastic growth prospects in one of the long-term most promising industries in China: tourism. China Yida is widely unknown, very thinly traded with an average daily volume of about 30,000 shares, but it should be pretty safe for a Russell addition and I would expect its investor base to broaden significantly with the index inclusion. I am buying 300 shares of CNYD at Friday's close of $13.55. I expect that the stock takes out its old highs ($16.05) within the next three months and I have a 12-18 months target of $25 on the stock.

Shengkai Innovations (SHE)

This widely unknown company is the dominant provider of industrial ceramic valves in China. I can't possibly try to explain this business but Shengkai has a very nice presentation out that you should dig into. The scenario is similar to China Yida, the stock is very thinly traded and held up well in the recent China Small Caps downturn. I would expect it to move into the double digits within the next two months and from there it should reach the high teens within a year as EPS of $1+ are very likely for FY2011. I am buying 500 SHE at Friday's close of $8.47 with a 1-3 months target of $12 and a 12 months target of $18.

Russell 2000 Reconstitution Preview

IMPORTANT: This post has been updated (click here)

The Russell 2000 Index's annual reconstitution is an event every small cap investor should be prepared for and watch closely. Inclusion in the world's leading small cap index has enormous benefits for the growth stocks I am covering here on this blog, including much enhanced liquidity, gaining a larger investor base and especially much broader exposure amongst institutional investors and independent analysts.

For those of you who are not familiar with the Russell methodology, here is how it works. Russell will rank the US common stocks from largest to smallest market capitalization on the last trading day in May. The largest 1,000 stocks become the Russell 1000 Index and the next 2,000 stocks become the Russell 2000 Index. Excluded are stocks trading below $1.00, pink sheet and bulletin board stocks, foreign stocks and American Depositary Receipts (ADRs), and closed-end mutual funds, limited partnerships, royalty trusts, SPAC's etc.

For 2010 the relevant dates are the following:

• May 31: Stocks will be ranked by market capitalization
• June 11: Preliminary additions and deletions to the Russell Indexes published after 3:00 pm PST
• June 18: Updates to the list of additions and deletions
• June 25: More updates and final reconstitution after the close of the US markets

There is a potentially enormous addition/deletion effect on the stock price of the added or dropped companies. Asset managers whose portfolios reflect the composition of the Russell 2000 will need to buy or sell stocks in proportion to their new weighting. That will make June 25 most likely the busiest trading day of the year with record turnover and huge volatility especially into the close. For 2009 NASDAQ reported a new record with 1.002 billion shares representing $9.2 billion executed in the Closing Cross in 2.9 seconds.

Now, in theory, new additions to the index should appreciate in price in anticipation of the June 25 action while deletions should see some selling pressure as soon as their preliminary deletion is announced. Thinly traded stocks should on average see the highest volatility and biggest price jumps. If we can identify likely candidates for both additions and deletions early, we can possibly make good returns with taking positions in those stocks before preliminary index changes are announced.

Let's have a look at potential candidates in the China small caps space and - most importantly - what could the market cap threshold for entry into the 2010 Russell 2000 Index be.

Last year the market cap threshold was just $78 million, a record low since 1993 and down from $167 million in 2008. The reason for this big drop was that at the end of the financial crisis downturn, when mid- and larg-cap companies held up relatively well, small caps were still underperforming the general market. As we all know this has changed dramatically over the last twelve months.

From May 31, 2009 until today (April 30, 2010), the Russell 2000 gained 42.86%, which is a far better performance than the general market as measured by the S&P 500 which gained "just" 29.11% in that period. Year-to-date the Russell 2000 outperformed the large cap Russell 1000 as well with a return of 15.01% compared to 7.65%.

We can safely assume that this year's market cap threshold will be much higher than 2009's $78 million and many of last year's addition will be deleted again if they haven't at least doubled in price. I will go with a threshold of $150 million for now, treating companies with a market cap between $120 million and $180 million as uncertain candidates.

Current Russell 2000 Members		Market Cap
CAAS	China Automotive Systems	$703 million
HRBN	Harbin Electric	$680 million
HOGS	Zhongpin	$437 million
CHBT	China-Biotics	$429 million
CSR	China Security & Surveillance	$411 million
WATG	Wonder Auto Technology	$393 million
CFSG	China Fire & Security	$378 million
ADY	American Dairy	$373 million
SDTH	ShengdaTech	$372 million
AOB	American Oriental Bioengineering	$363 million
FSIN	Fushi Copperweld	$331 million
CAST	ChinaCast Education	$304 million
CPBY	China Information Security	$299 million
CGA	China Green Agriculture	$295 million
FUQI	Fuqi International	$270 million
DYP	Duoyuan Printing	$253 million
COGO	Cogo Group	$252 million
ABAT	Advanced Battery Technology	$240 million
CSKI	China Sky One Medical	$237 million
GSI	General Steel Holdings	$193 million
FEED	Agfeed Industries	$193 million
CTFO	China TransInfo Technology	$158 million
UTA	Universal Travel Group	$152 million
NIV	NIVS IntelliMedia Technology	$131 million
CBAK	China BAK Battery	$126 million
CHLN	China Housing & Land Development	$110 million
SUTR	Sutor Technology	$104 million
HQS	HQ Sustainable Maritime	$84 million

Based on Friday's close I would expect only China Housing, Sutor and HQS to be deleted from the Russell 2000, and four more stocks being at risk. Of course there is still a full month to go and things could change dramatically from here on. Now let's have a look at possible additions from the China small cap space.

Possible Russell 2000 Addition		Market Cap
CCME	China MediaExpress	$535 million
RINO	RINO International	$493 million
SCOK	SinoCoking Coal	$474 million
CBEH	China Integrated Energy	$426 million
GFRE	Gulf Resources	$371 million
CVVT	China Valves Technology	$347 million
YONG	Yongye International	$340 million
CXDC	China XD Plastics	$301 million
LLEN	L&L International	$297 million
CAGC	China Agritech	$281 million
CBPO	China Biologic Products	$281 million
SHE	Shengkai Innovations	$262 million
LIWA	Lihua International	$256 million
DEER	Deer Consumer Products	$240 million
CNYD	China Yida Holding	$237 million
NEP	China North East Petroleum	$212 million
CELM	China Electric Motors	$196 million
SORL	SORL Auto Parts	$194 million
CHNG	China Natural Gas	$193 million
QKLS	QKL Stores	$170 million
PUDA	Puda Coal	$165 million
TBV	Tiens Biotech	$163 million
ONP	Orient Paper	$155 million
CMFO	China Marine Food	$150 million
CREG	China Recycling Energy	$146 million
CPHI	China Pharma Holdings	$146 million
CEU	China Education Alliance	$146 million
TSTC	Telestone Technologies	$144 million
WWIN	Winner Medical Group	$140 million
YUII	Yuhe International	$140 million
CNGL	China Nutrifruit	$138 million
BSPM	Biostar Pharmaceuticals	$129 million
SPU	SkyPeople Fruit Juice	$123 million
CWS	China Wind Systems	$113 million
KNDI	Kandi Technologies	$107 million
TPI	Tianyin Pharmaceutical	$107 million
AXN	Aoxing Pharmaceuticals	$100 million
ALN	American Lorain	$96 million
CRTP	China Ritar Power	$94 million
GRPC	Guanwei Recycling	$88 million

Our screen identifies a large number of Chinese stocks that will probably make the cut. Many of the names on this list are companies which uplisted from the bulletin boards since March 31, 2009 and this year's reconstitution will be their first chance to get added (Russell is only adding regular IPO's like DYP on a quarterly basis). Some of those names like CAGC, RINO or the coal stocks are already trader's favourites and the announcement of their addition will likely get a lot of buzz because of the stocks' popularity. Other names on this screen do currently have a small investor base and trade on very thin volume. I would expect the addition effect for stocks like CNYD or SHE to be greater than average.

I will make adjustments to the China Model Portfolio shortly, based on the results of this screen: Russell 2000 - Reconstitution Screen for China Small Caps.

Investor Presentations Database

Sorry for the lack of updates recently, but I've been working on several additions to the site that I hope will be useful.

Investor Presentation Database

A comprehensive list of investor presentation slides that are available online for Chinese small cap companies. I tried to add HTML versions where possible, but most companies only offer PDF or Powerpoint slides which you have to download from the respective links.

Analyst Coverage

Whenever I can verify new analyst notes about those Chinese stocks covered by this site I will add the rough data to this database: action (Initiation, Upgrade, Downgrade, Reiteration), rating and price targets. It takes a while to populate the database with data of the past six months, it is about 60% done at the moment.

Business Outlook Database

A database of official company statements published in SEC filings or press releases. I will add new statements about revenue or earnings guidance, relevant business developments and official expectations and targets to this database when they occur. It does not cover other potentially price-moving announcements as secondary offerings, stock splits or debt restructuring.

Updated Score Cards

The individual score cards within the China Tracker now show a summary of all this information for every stock we cover. Next to the fundamental data you will now see our projected forward earnings, business outlook statements, analyst ratings and links to available investor presentations. These score cards are designed to be a one-stop destination to get a quick overview of the company you are researching. For more in-depth analysis you will still have to read all of the company's filings with the SEC.