During the past decade, dozens of Chinese companies began trading on U.S. stock exchanges, and more than a few were complete frauds, causing investors to lose 100% of their money.
You can blame it on the auditors. The accountants who were tasked with digging deeply into these companies' books never made much of an effort. They willingly signed off on the veracity of financial statements, even though many numbers were a work of fiction.
As a result, many U.S. investors concluded it's wise to steer clear of Chinese companies altogether these days.
And that's a shame, because China, warts and all, has the most fertile economic climate in the world. Its economy has been growing at a fast rate for more than a decade and, by some accounts, will overtake the U.S. economy within a few decades.
Swinging for the fences
Investors' troubles resulted when they erroneously equated high growth with small company size. The notion of a fast-growing economy immediately leads investors to think about finding little acorns that can grow into big trees.
Take ChinaMedia Express Holdings. This relatively obscure company claimed to be China's leading player in alternative advertising -- for example, ads found on the sides of businesses and on elevator video monitors.
ChinaMedia's management issued a series of gushing press releases that noted robust sales growth. The company eventually sported a market value of hundreds of millions of dollars. But by 2010, rumors had swirled that the company was cooking the books, so investigations were launched into the company's specious claims of nationwide ad sales.
By the time auditing firm Deloitte said it could not verify the company's claims, it was too late -- ChinaMedia's stocks had been halted and would never trade again.
Lesson learned
These days, U.S. investors are edging back toward Chinese stocks, but in a different way. They are seeking large, stable companies with long track records and proven market share. The long track record is crucial. If a company were fraudulent, then that would have become apparent in a few years. But if a company has been operating in the public sphere for more than a decade, then it's unlikely it's a sham.
Based on these two principles, here are four stocks to consider...
| China Mobile (NYSE: CHL) This is China's largest wireless service operator -- "the Verizon of China," if you will. The $232 billion market value attests to its solidity. To be sure, sales growth mirrors the Chinese economy, averaging 9% in each of the past three years. But with a national network that is largely established, investors can enjoy the prodigious free cash flow that China Mobile now generates. In fact, free cash flow exceeded $10 billion for the first time in 2010. | |
| China Southern Airlines (NYSE: ZNH) As an economy grows, businesses and consumers step up their travel plans. And that's surely been evident for China Southern, one of the country's largest carriers. Sales have doubled since 2006 to about $15 billion this year. But don't think of this as "the Delta of China." Perhaps JetBlue (Nasdaq: JBLU) or Southwest Airlines (NYSE: LUV) is a more apt analogy. China Southern's fleet of planes is quite young and fuel-efficient, and the company continues to expand into dozens of cities surpassing 1 million in population. | |
| Baidu.com (NYSE: BIDU) As the Chinese economy grows, the rate of Internet usage steadily expands. Web usage is rising at a 10% annual pace, according to the China Internet Network Information Center. Still, just 40% of all Chinese are online these days, well below the levels seen in neighboring Japan (80%) and South Korea (83%). With time, that gap should narrow, helping to fuel further growth for Baidu.com, known as "the Google of China." Baidu's sales have risen a minimum of 39% annually going back to at least 2004 and now approach $3 billion. Yet considering the still-rising Internet penetration rate, this looks like a long-term winner. Still, in the short-term, investors have seen the flip side of growth investing. A slowdown in the Chinese economy has pulled the stock down from $150 last spring to a recent $94. Looked at another way, investors who missed this stock's meteoric rise have just been handed a second chance while shares are on sale. |
| iShares FTSE China 25 Index Fund (NYSE: FXI) Rather than focusing on specific stocks, some investors like to take the basket approach, and this exchange-traded fund (ETF) is the most popular way to invest in China. It typically trades more than 16 million shares every day. The fund owns all of the companies that are members of the FTSE China 25, which are the 25 largest and most liquid stocks in that country. This brings exposure to all corners of the Chinese economy, and the ETF carries a reasonable 0.74% expense charge. |
> Economists grew concerned earlier this year that the Chinese economy was headed for a major slowdown. Those concerns appear to have receded, and the Chinese economy now looks set to keep growing at very fast pace in 2013.
Though it will be hard for China's economy to keep growing continually at an 8% annual clip, as has been the case for the past decade, longer-term growth rates are still likely to be higher than what we'll see in the mature economies of Western Europe and the United States. That's why it's not too late to pursue Chinese stocks. And these companies, plus the ETF, possess a solid, broad-based approach to that growth.
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