Buy the Fastest-Growing Stocks

Here's what we know about China:

  1. It has the world's fastest-growing economy.
  2. The stocks look expensive.
  3. Government regulation is a total wild card.

Combine those points with a novice investor class that's been pushing up prices based (reportedly) on momentum, lucky numbers, and taxi-driver stock tips, and I was downright petrified of investing in the country.

Until I went there.

Epiphany ahead
I recently accompanied Motley Fool Global Gains advisor Bill Mann on a tour of China, where we met with companies, analysts, and investors on the street. It was an eye-opening experience. Not only am I ready to put my money to work in China, but I'm kicking myself for not having done so sooner.

Because here's what I now know about China:

  1. It has the world's fastest-growing economy.
  2. The stocks look expensive.
  3. Government regulation is a total wild card.

So, not a lot changed
While the basic facts of Chinese investing remain the same, I returned to the States (and boy, is it nice to be back) thinking that there are some select opportunities to get significant gains over the next decade or more.

But before I get to where those opportunities are, let me tell you about where those opportunities are not ...

Don't bother with big names
Chinese large caps look pretty efficiently priced. For example, $252 billion PetroChina is widely covered by analysts and trades for 13 times earnings, while $298 billion China Mobile -- another China bellwether -- trades for 29 times earnings.

While both are expected to grow modestly faster than their multinational counterparts, that growth is fairly predictable for such mature companies, and it seems to be priced into the shares. PetroChina (13 times earnings) trades for a modest premium to BP (NYSE: BP  ) (11 times earnings) and Chevron (NYSE: CVX  ) (10 times earnings); China Mobile (29 times earnings) is pricier than NTT DoCoMo (18 times earnings).

So while those are fine companies with real advantages in the Chinese market, American investors will be better rewarded elsewhere.

Mapping elsewhere
One of the major long-term trends in China is growing affluence in an emerging consumer class. These spenders have more discretionary income than ever before, and they now number some 300 million -- the size of the entire U.S. population! What's more, that market of 300 million spenders is growing rapidly, as some 18 million Chinese migrate to the cities each year to get higher-paying jobs.

Yet according to research by Roth Capital, the retail/consumer sector in China accounts for the smallest percentage of the domestic economy of any country in the world.

With the consumer class exploding, that won't be the case for long. And that's where your opportunity as an investor lies.

Buy the next ...
Which industries benefit from the rise of an urban middle class with disposable income? How about retail apparel, hotels, and casinos, for starters? There's also restaurants and luxury homebuilding. Retail sales in China, for example, are already growing 12% annually.

If the United States is any sort of model, companies that dominate these niches in China will do very well for investors:

Company

Industry

Trailing-10-Year Annual Return

Nordstrom (NYSE: JWN  )

Retail

12.8%

Ameristar Casinos 

Casinos

23.1%

Yum! Brands (NYSE: YUM  )

Restaurants

18.2%

D.R. Horton (NYSE: DHI  )

Homebuilding

12.6%

Mark my words: Each one of these companies will soon have a Chinese counterpart. While that company may be small today, or may not even be public, that's the company whose shares we want to own for the next decade or more.

These are precisely the companies Global Gains advisor Bill Mann is looking to recommend for his subscribers. And I can tell you that our recent trip to China gave him the beat on a few of them. If you're interested in taking a look at the service and our recommendations, and reading about more ways to profit from China's incredible growth, check out Global Gains free for 30 days. Click here for more information.

This article was first published June 26, 2007. It has been updated.

Tim Hanson does not own shares of any company mentioned. Ameristar Casinos is a Motley Fool Hidden Gems recommendation. The Fool's disclosure policy also awaits a Chinese counterpart.


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