May 29, 2008 9:17AM

Beware this Hot China Stock: China Finance Online

By Elizabeth MacDonald

It’s one of the hottest momentum stocks in China today.

It’s China Finance Online (JRJC), a Beijing company that’s due out with a profit report today that Wall Street has been anticipating for weeks now, as its American depositary shares soar ever higher in Nasdaq trading in anticipation of yet another rosy earnings outlook.

China Finance has been riding the stock mania that’s got indices on the mainland in bubble territory. Investors in China are pouring into stocks, grabbing returns while they can as they fear the Chinese government will punt on providing sufficient coverage for health care and retirement. China Finance is perched atop that wave.

The company purports to sell the best in financial information online, with news flashes and updates to investors on the mainland and abroad so they can get in on the action in China’s stocks too. Its website says it sells users “software tools” to “analyze financial and listed company information” on all sorts of stocks, bonds, and mutual funds.

Not so fast. There is a growing chorus of critics who say this stock is way too frothy. My read of its numbers shows it’s been bleeding losses for some time now. It’s got a negative 16% profit margin, a negative 6% return on equity, just a 3% return on assets, a tiny $5.7m in cash flow over the last 12 months on just $25m in trailing twelve month revenues.

This one might be a trade not an investment.

Here’s more analysis from Citron Research. See below. I tried to do what Citron did with China Finance Online’s website and met with the same results. Now I’m waiting for the lame telemarketing spam to hit my emailbox as well as arrive in snail mail. Why oh why do I do these things:

Folks, the company sells a group of newsletters to Chinese stock speculators with names like “Quick Profits” and “Storm” and “Stock Radar.” They sell by telemarketing, and they have plans to increase their telemarketing staff again next year.

If you hit the “Purchase” or “Free Trial” buttons, you can’t even order online. The form sends an email to a telemarketer who will presumably respond to your request and try to upsell you something.

The reality is there are hundreds of competing stock commentary publications in China. This has gone from silliness to nonsense. The chatrooms calling this the “Bloomberg of China” are well……out to lunch.

Now Breen Murray has raised its target from $25 to $35 while cautioning about the need for a “market correction” due to volatility.  What has changed since Breen put out its $25 target, which was a raise from $17 just the week before, except the momentum in the stock?  Did Breen’s analyst fail to understand this company as the “Bloomberg of China” until the stock price told him?

The JP Morgan analyst put a $29 target on this company as of Dec 08, with a very detailed revenue projection based on the company’s plans. Will he have the integrity to call a “sell on valuation” now, or will he raise his target because of the stock price?

After breaking its IPO price of $13 right out of the gate in late 2004, and languishing in low single digits for well over two years, this tiny company which publishes investment guides for Chinese stocks has this year rocketed to a 1000% gain on the mania surrounding the China stock market.

Most recently, shares rocketed higher on the purchase of a Hong Kong brokerage firm for about $3m. Recent momentum trading has now driven this company with revenues about $5m or $6m per quarter from newsletter subscriptions above an $800m dollar market cap.

Citron observes that management has not been able to execute over the past three years during the biggest boom in the China market while positioning themselves in a space with a low barrier to entry. We acknowledge they have now gotten their revenues up to $5m per qtr. But we doubt Bloomberg is jealous.

Now we are not issuing a wholesale critique of China stocks–a lot of them have some impressive growth rates to show for their skyrocketing valuations. It is just important to decipher what is a bubble and what is value.

Think of JRJC as Thestreet.com for China, yet even in the tremendous market boom the company was only able to generate $7.4m in revenue in all of 2006, and projects about $20m for the current year.

Comparatively speaking TSCM generated $57m in revenue and has a market cap of about third this name.

This has become a quintessential example of the uncritical cheerleading that Wall Street has become so famous for–and that has burned investors. So, don’t be surprised if Chinese stocks catch a cold and JRJC gets the flu.