Why you might want to avoid Chinese listed ASX stocks

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Mike King

Mike King is a Fool.com.au Investment Analyst and Writer. He caught the investing bug more than a decade ago, at a time when the U.S. had invaded Iraq and fear reigned in the markets. His initial success as the markets took off encouraged his passion and thirst for knowledge. With 13 years behind him at one of Australia's largest domestic banks, Mike's passion for stocks led him to join a boutique funds management firm, where he stayed for four years. A seven-year stint in equity research at one of the largest investment banks in the world followed that, giving Mike a thirst to pursue his passion further. Mike holds a Diploma in Applied Finance and Investment and a Graduate Certificate in Financial Planning. His passion is to help retail investors invest better, and that passion was one of his primary reasons for joining The Motley Fool Australia in late 2011. Mike has written thousands of articles since joining, including for Fairfax Media, Yahoo!7, Ninemsn and has also appeared on ABC's The Business. You can see all of Mikes' holdings here

Published July 22, 2014 3:12 pm AEST

There have been a growing number of companies listing on the ASX with operations in China, but investors need to be fully aware of what they are getting into.

It's not like an Australian-operated business, where an individual investor can pretty quickly find out a great deal of information about the company, its suppliers, customers and other stakeholders. Unless you read or speak Chinese, finding out more details about a subsidiary company operating in China is much more difficult. Investors also need to be fully aware of local rules, common business practices and law. It also makes it easier for the company to make mistakes and for fraud to occur.

For example, a large number of Chinese stocks listed on US exchanges in recent years were found to be fraudulent or showed a complete disregard for corporate disclosure; one company lent its CEO US$3.5 million without asking for a signed loan document, and more than a few were found to have reported one set of numbers to the US regulator, and another completely different set to Chinese authorities.

And questions have also arisen over the value of their audits. Some auditors outsource their work to unsupervised Chinese auditors, or signed off on audits without sending anyone to China. There is also the issue that audit work conducted by a local Chinese auditor could be classified as state secrets and therefore can't be given to international auditors. It's probably no surprise that a number of US-listed companies tarred by allegations of fraud shared the same auditors. Even 'big four' accounting firms like Deloitte and Ernst & Young were caught out in the US – not that that helped investors out much.

Now I'm not saying that the practice has definitely found its way to Australia, just that investors need to show more than extra caution when investing in companies with operating businesses in foreign countries. If it looks too good to be true, it probably is.

You only have to look at two recent listings, U & D Coal Ltd (ASX: UND) and Sino Australia Oil and Gas Ltd (ASX: SAO). Both companies are suspended with U & D's majority shareholder alleging directors had breached their duties, while Sino Australia is in 'discussions' with the Australian Securities and Investments Commission (ASIC) over a $7.5 million transfer of funds.

So before you jump into buying shares of companies like Shenhua International Ltd (ASX: SHU), 99Wuxian Ltd (ASX: NNW), Sunbridge Group Ltd (ASX: SBB) or Victor Group Holdings Ltd (ASX: VIG), make sure you are fully aware of the extra risk you are taking on. In fact, most Foolish (with a capital 'F') investors may want to avoid them altogether and read on for better ways of building a $1 million portfolio…

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