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 collections of stocks that share certain elements. If investors want to capitalize on the booming growth in China, they can turn to iShares FTSE/Xinhua China 25 Index, whose top holdings include China Telecom and CNOOC (NYSE: CEO). But because this ETF invests in a number of stocks, its broad diversity also limits your upside.

Fear not, Fool -- in this edition of "ETF Teardown," we'll use some nifty tools to drill into the best Chinese investments. 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 locate great stocks quickly, CAPS-rated stocks are tagged with descriptors that group the company with others in the same category -- "Foreign Utilities," for example, or "Uranium."

Selecting the "China" label in CAPS gives you a list of 134 investments that are tied to the People's Republic of China. Today's collection has handily beaten the market in the past year, up 20.4%, while the S&P 500 has ticked down by 4.4%.

To gauge which companies the CAPS community thinks offer good opportunities in this particular region, we'll sort these businesses by their CAPS star rank, from one to the maximum five stars. We'll then examine a couple of the companies to see who -- from Wall Street to Main Street -- is bullish or bearish on the business, and why.

Down to the nitty-gritty
Here are Chinese stocks I've pulled from CAPS today:

Chinese medicine
Taking advantage of capital eager to be deployed internationally, several Chinese companies have launched IPOs on American exchanges over the past few years. Pharmaceutical maker 3SBio launched its public offering in February 2007, but the stock sits some 50% below where it made its debut.

While some investors have been calling S3Bio the Chinese Amgen (Nasdaq: AMGN), the tiny upstart so far hasn't performed as many thought it would. The company is leveraging the advantages of low-cost development and manufacturing in China to profit nicely from its knockoff of Amgen's Epogen, as well as a drug typically used to stimulate platelet production in cancer patients undergoing chemotherapy. But in its most recent earnings report, the company guided revenue growth in 2008 to a range of 22% to 30%, a level far below what Wall Street had been hoping for and the 41% growth achieved in 2007.

While 3SBio has a pipeline of cash-flowing drugs, it has experienced recent delays in three of its phase 3 candidates. The company had hoped to complete all three studies by the end of 2007, but each is now being pushed to at least mid-2008. The collective groan from the market dropped shares to a level near 15 times trailing earnings. But many CAPS players think the reaction is overdone and that 3SBio still represents a superior growth opportunity. Voting to buy while others sell, 230 out of the 235 CAPS investors rating the company believe it will beat the market going forward.

Live and learn
Another highly rated Chinese investment and recent U.S. market IPO is feeding the need for expanded education and training services in China, where people are leaving unskilled jobs in droves to join higher-paid positions across a number of industries. But, like many companies, New Oriental Education recently got sent to the principal's office for being too pessimistic about growth in its current quarter. After handily impressing the Street with its  first-quarter earnings in October, the company's fiscal Q2 report in January sent shares down more than 35% in little more than a week.

New Oriental's sky-high valuation probably gave investors the itchy finger, as the company still has an earnings multiple of 53 after the drop. But more than 93% of the 262 CAPS All-Stars rating the company think the long-term growth prospects outweigh the risks and are bullish on New Oriental.

You can lead a horse to water ...
Plucking individual stocks from China is, of course, a high-risk endeavor. Investors should always perform their own due diligence on companies.

So, do you agree that Chinese biotechs have plenty of upside? Or are private education plays better positioned? Give your opinion in Motley Fool CAPS.