That’s not to say there aren’t stocks with that type of potential residing in China — in fact, someone asked an unrelated, but an interesting, question on picking small-cap stocks in China:

“How would you go about picking small-cap stocks in China?”

So this got me thinking — let’s say I took the analysis I began in my article from last week, and went a step further and tried to identify some small cap plays in China using a similar strategy.

My approach to the market, and this sector in particular, has always been to take a top-down approach. I try to find the strongest companies, in the fastest growing sector of the hottest markets. So let’s apply that thinking here…

The “hot” market is China and one of the fastest growing sectors is wireless technology. And now we’ll add some market capitalization requirements — let’s say that we’ll be examining wireless companies that are trading under a $500 million market cap.

Immediately, three companies show up on my radar:

• China TechFaith Wireless (CNTF: NASDAQ)
• Qiao Xing Mobile Communication  (QXM: NYSE)
• Orsus Xelent Technologies (ORS: AMEX)

China TechFaith designs and manufactures mobile handsets for the Chinese market and abroad. They’ve had a rough go of it for the last two years, but the last 12 months have treated the company well.

Next we have Qiao Xing Mobile, which also produces wireless handsets and has done very well over the last 12 months. However, the company has had a recent hiccup in the stock that has brought prices down a bit.

And finally we have Orsus, which produces more multimedia-oriented phones for the Chinese mobile market.

So now the question is, how do we narrow these down so we can find the strongest company out of the three?

Let’s start by setting up some basic criteria:

1. Since we don’t want to fish in a pond where the fish might be dirty, we’ll limit ourselves to a market cap of over $100 million.
   
2. Because I’m a value-oriented investor, I want to make sure the fundamentals are sound in any company I invest in. So, the next criterion we’ll setup is that the company has to be profitable for the last three years.
   
3. And finally we’ll want to make sure we’re investing in a company that has had some solid momentum behind it — so we’ll only look at the best performers for the last 12 months.

So here goes…

The best performers over the last 12 months, in order are: China TechFaith, Qiao Xing and Orsus. The only two companies that have been profitable for the last three years were Orsus and Qiao Xing. And since Orsus’ market cap is below $100 million, Qiao Xing is the only company that meets all of our criteria:

If you take a look at a chart of QXM you’ll see that the stock is down almost 15% in the last few weeks on a disappointing fourth quarter (even though they beat expectations). To me, it’s a temporary blip on the radar and it might be smart to buy on weakness here for the long term.

Click here to check out some other short-term China plays or to share some of your own.

Until next time,

Wayne Mulligan
May 6, 2008

P.S.: Penny Stock Fortunes editors Greg Guenthner and Jim Nelson recently recommended a tiny Chinese pharmaceutical company that is set to become the clear industry leader. So far, it’s paid off. In exactly one month, it’s up 45% for their readers. No worries though…

A Chinese Penny Stock for Your Portfolio was originally featured in the Penny Sleuth.