ETF Teardown: China's Best Stocks

Noted for their simplicity and other advantages over mutual funds, exchange-traded funds have become a popular investing tool. ETFs hold a collection of stocks that share certain elements in common, so that if investors want to capitalize on the booming economy in China, for example, they can turn to iShares FTSE/Xinhua China 25 Index (NYSE:FXI) or PowerShares Golden Dragon Halter (AMEX:PGJ), which track two different Chinese stock indexes.

But since these ETFs invest in a number of stocks, they give you a broad diversity that also limits your upside. For an investor who was, say, really hip to oil and gas explorers in the region but cold on the future prospects of Chinese Internet stocks, these ETFs wouldn't fit the bill.

Fear not, young grasshopper -- in this edition of "ETF Teardown," we'll use some nifty tools to drill into the best of what China has to offer. To help, we'll use Motley Fool CAPS, our tool for screening and ranking stocks and stock pickers.

The power of tags
To help investors quickly locate great stocks, any of the 4,300 rated stocks that are profiled in CAPS can be "tagged" with a descriptor that groups the company with others that share a certain quality.

Selecting the "China" tag in CAPS presents a list of more than 50 Chinese investments -- one of them being the iShares FTSE/Xinhua China 25 Index -- that trade on American exchanges. This particular collection of investments has done well in the past year, up 19.1% versus the S&P gain of only 13.2%.

To get a sense of which companies the CAPS community thinks are the best opportunities in China today, we can sort this list by their CAPS star rank, denoted by one to five stars, with five being the best. Each of the individual companies can then be viewed for exactly who -- from Wall Street to Main Street -- is bullish or bearish on the company and why.

Getting down to the nitty-gritty
Here are a few of the five-star stocks our screen pulled up today.

In looking at what the CAPS community favors in China, a few industries stand out, one of them being telecommunications. While China has a rapidly growing population of more than 1.3 billion people, only 369 million of those had fixed-line telephone service and 467 million subscribed to wireless communications services as of the end of January. It's hard to comprehend that even though China Mobile alone has more wireless subscribers than the entire population of the United States, there is still a huge untapped market for mobile communications.

The low penetration rate of telecommunications and the influx of low-cost, domestically produced cell phones catapulted China Mobile's returns by 85% in 2006. With the Chinese Ministry of Information Industry (MII) aiming to have more than 1 billion people subscribing to telecommunications services by 2010, China Netcom and China Mobile are two of the four major telecommunication companies sitting in the catbird seat of this major growth market. Of the 928 CAPS members rating the China Mobile, more than 97% of them think that it will outperform the S&P going forward.

Another area with companies getting five-star ranks is the realm of oil and gas producers, such as CNOOC and Sinopec. CAPS players favoring these companies see steady growth, courtesy of increased demand and high dividends, as reason to own these companies. CNOOC and Sinopec returned 44% and 92%, respectively, in 2006, and bulls outnumber bears on each company by more than 20-to-1.

You can lead a horse to water ...
Plucking individual stocks from an emerging market such as China is, of course, a high-risk endeavor. Investors should always perform their own due diligence on companies rather than take a recommendation -- after all, even the best stock pickers can be horribly wrong on a stock.

So do you agree that telecom and oil/gas are still the best places to be in China? Or are Chinese Internet companies a better play? Give your own opinion in Motley Fool CAPS.

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Fool contributor Dave Mock loves doing the teardown part -- it's the put-back-together part he hates. He owns no shares of companies mentioned here. Mindray Medical is a Rule Breakers recommendation. Dave is the author ofThe Qualcomm Equation. The Fool has a disclosure policy.