Chinese Parts Supplier Makes Guru's Grade

09/29/2010 11:28 am EST

Focus: STOCKS

John Reese

Founder and CEO, Validea.com And Validea Capital Management

John Reese, editor of Validea Hot List, says a Chinese auto parts maker rates a Buy based on criteria used by the legendary investor Martin Zweig.

China Automotive Systems (Nasdaq: CAAS) is a holding company [that, through] its interest in Great Genesis Holdings Limited (Genesis), manufactures power steering systems and other component parts for automobiles. All operations are conducted through eight Sino-foreign joint ventures in China and a wholly owned subsidiary in the United States.

The company has business relations with more than 60 vehicle manufacturers, including Chery Automobile, the state-owned car manufacturer in China, and [car manufacturer] Zhejiang Geely Automobile Co., Ltd. (It scores 85% on Validea’s ranking system, based on the theories of growth investor Martin Zweig—Editor.)

[According to Zweig,] a company’s price/earnings ratio (P/E) must be greater than 5x to eliminate weak companies, but not more than three times the current market P/E because the situation is much too risky. CAAS's P/E is 14x trailing-12-month earnings, while the current market P/E is [above] 16x. Therefore, it passes the first test.

[Also, Zweig believes] revenue growth must not be substantially less than earnings growth. CAAS's revenue growth is 38.1%, while its earnings growth rate is 42.09%, based on the average of the three-, four-, and five-year historical [earnings per share] growth rates. Therefore, CAAS passes this criterion.

The earnings numbers of a company should be examined from various different angles. The first of these criteria is that the [current earnings per share (EPS) and EPS for the quarter a year ago] be positive. CAAS passes this test.

The growth rate of the current quarter's earnings compared to the same quarter a year ago must also be positive. CAAS's growth rate of 47.4% passes this test.

Earnings growth in the previous three quarters should be at least half of the long-term EPS growth rate. CAAS passes this test, which means that it has good, reasonably steady earnings.

[Also,] the EPS growth rate for the current quarter, 47.4%, must be greater than or equal to the historical growth, which is 42.19%. CAAS would therefore pass this test.

Companies must show persistent yearly earnings growth. To fulfill this requirement, a company's earnings must increase each year for a five-year period. CAAS passes this test.

One final earnings test required is that the long-term earnings growth rate must be at least 15% per year. CAAS's long-term growth rate of 42.1%, based on the average of the three-, four- and five-year historical [earnings per share] growth rates, passes this test.

v A final criterion is that a company must not have a high level of debt, [which] can have a very negative effect on earnings if business moderately turns down. CAAS's debt/equity ratio (66.2%) is considered high relative to its industry (39.9%) and fails this test.

(CAAS closed near $15.50 Tuesday—Editor.)

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