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Here are the seven criteria I used to select my portfolio:

  1. Other receivables/Total assets<10%

In Chinese companies, ˇ°other receivablesˇ± is a very tricky accounting term. Normally, the amount of this account should be zero and tiny, representing the advances for traveling and salaries, etc. However, in some cases, the unlisted parent company often uses its listed subsidiary as cash machine and takes money away for no reason. Since the Chinese regulation prohibited financial borrowing and lending between non-financial firms, listed companies usually record the money taken by their related companies into ˇ°other receivablesˇ±.

  1. Other operating cash inflow/total operating cash inflow<10%

In order to have a healthy and sustainable cash inflow, a company should mainly receive some cash from the sales of its goods or services.

  1. Other cash outflow investing/Total cash outflow investing<10%

When a company invest, it should invest into something (tangible assets, intangible assets, equity or bonds, just name them.). But sometimes, some companies do invest into something other than all the possibilities I named beforeˇ­

  1. Non-operating income/sales<10%

Non-operating income is often used by companies to window-dress their net income. I did a study with Dr. ZHANG Hua (CEIBS) and Prof. ZHANG Junxi (University of Hong Kong) on this issue in China.

  1. Operating cash flow>0

The major problem of accounting earnings is accrual-based. Companies may easily manipulate it by using some non-cash items. Remember: Cash is the king!

  1. ROA>7% for three consecutive years

ROA is a good measure for the economic profitability of a firm and it is difficult to cook their book for three consecutive years.

  1. P/E<20

Here we enter into a question of philosophical debate and personal favor. Many investors would say: a high P/E means the firm has a high potential growth. For me, this is exactly like the dilemma you are facing when you have in front of you two vendors both selling the cabbage: one sells normal one with normal price and the other claims that he is selling the organic one with double price. I prefer to pick the first, since I know at least I get the price.