This Is Why I'll Make Money in China

Let me be straight with you: I didn't own a single Chinese stock prior to 2008.

You may think that's shocking, considering I'm the co-advisor of our Motley Fool Global Gains international investing research service. But prior to 2008, Chinese stocks were very expensive. That didn't stop many American investors, smitten with these stocks' momentum and potential for growth, from buying them up. 

Today, I own sizeable chunks of three Chinese stocks, and I have my eye on a handful more. That's because these stocks have been crushed, and they now look quite cheap relative to their growth potential.

Of course, now most American investors won't touch these stocks with a 10-foot pole.

Or even a 20-foot pole
If you read my last column, you know I'm less skeptical than most of a recent $70 million property acquisition by a Chinese company called American Oriental Bioengineering. In fact, I believe the acquisition will yield important economic benefits.

Yet since that acquisition, investors have shaved more than $180 million off AOB's market cap. That's more than twice the amount of cash that came off the company's balance sheet to buy the property, indicating that American investors actually think that with this infrastructure purchase, AOB is reducing the value of its core business.

But if you look at AOB's financial statements, you'll see a fast-growing company that's generating gobs of free cash flow. So why would investors think that a building purchase is destroying shareholder value?

Frankly, they think China is a fraud.

I realized this the other day when ...
I went back to check the comments from readers at the bottom of that AOB column, and here's what I found readers were saying:

To be a successful investor in China, you must be an insider. Pretending there is western-style transparency in the market is a folly.... Be prepared to pay a lot of bribes and don't be surprised if some of the people you bribe end up dead.

And ...

The only companies worth investing in China are China Mobile (NYSE: CHL  ) , CNOOC (NYSE: CEO  ) , PetroChina (NYSE: PTR  ) , and Sinopec.

And ...

Subjecting Chinese companies to the same forms of analysis as you would a U.S. company is unrealistic. I wouldn't buy Iranian government bonds either. These are countries that make up written rules as they go along and abide by some very old unwritten rules that only apply to insiders.

And my personal favorite ...

China is run like an organized crime syndicate. I would no more trust a Chinese company with my money than someone that calls himself Fat Tony.

You get the point
Look, I'll be the first to admit that China is not all raindrops on roses and whiskers on kittens. But writing off the world's most populous nation and third-largest and fastest-growing economy as a criminal enterprise strikes me as ill-informed. As Warren Buffett has said, "A public opinion poll is no substitute for thought." 

China's growth potential is tremendous, but if you're going to invest in the country, you shouldn't do so with blinders on. That's true no matter where you invest.

After all, here in the United States over the past year, we've had the Madoff scandal, the collapse of a housing industry whose growth was fueled by the questionable practices of people like Franklin Raines and Angelo Mozilo, and billions upon billions of dollars worth of asset write-downs at once-proud institutions like Citigroup (NYSE: C  ) and Bank of America (NYSE: BAC  ) . Heck, one of the causes of this whole ordeal was a product widely referred to as a "liar's loan."

No matter where you invest, you are not immune to fraud, greed, or management teams that are not acting in your best interests. And yes, there are management teams like that in China. The important point is that it's not all of them. You can succeed by finding the good ones and diversifying your portfolio appropriately.

Going forward
Another Buffett quote is applicable here: "Be greedy when others are fearful." All you have to do is re-read the comments I cited to see that individual American investors are running away from Chinese stocks en masse. That means promising opportunities are being left behind, just as Apple (Nasdaq: AAPL  ) and Amazon.com (Nasdaq: AMZN  ) were after the tech bubble burst in 2000.

I've made it my mission to find those select China opportunities, and I'm doing so through careful research, meetings with management teams, learning the language, and visiting the country as frequently as possible. That's why I believe I'm going to make money in China over the long term.

If you'd like to join me, you can sign up for a free 30-day trial of Motley Fool Global Gains and get all of the notes from our research trips and company visits. Just click here for more information -- there's no obligation to subscribe.

Tim Hanson is the co-advisor of Motley Fool Global Gains. He owns shares of AOB. AOB is a Motley Fool Hidden Gems recommendation. CNOOC is a Global Gains pick. Apple and Amazon.com are Stock Advisor picks. Bank of America is a former Income Investor selection. The Motley Fool owns shares of AOB. The Motley Fool has a full disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 02, 2009, at 12:16 PM, pondee619 wrote:

    "Today, I own sizeable chunks of three Chinese stocks"

    "Tim Hanson is the co-advisor of Motley Fool Global Gains. He owns shares of AOB. AOB is a Motley Fool Hidden Gems recommendation"

    "The only companies worth investing in China are China Mobile (NYSE: CHL), CNOOC (NYSE: CEO), PetroChina (NYSE: PTR), and Sinopec"

    OK. So, you own sizable chunks of three companies in China. None of them are among the only companies worth investing in in China, since those companies were not listed as part of your holdings at the end of the article. You do own AOB, but that is not one of the only companies worth investing in in China. The article is about why YOU'LL make money in China, yet you write about only one of your three sizable holdings (AOB). If, in fact, AOB is a "sizable" holding.

    HUH?

  • Report this Comment On February 02, 2009, at 12:30 PM, TMFMmbop wrote:

    Pondee...

    "The only companies worth investing in China are China Mobile (NYSE: CHL), CNOOC (NYSE: CEO), PetroChina (NYSE: PTR), and Sinopec"

    That is a quote from a reader of a previous article who left a comment, and not my point of view. I think it speaks to the igorance with which American investors approach Chinese stocks. In fact, it's ridiculous to think there are only 4 companies worth investing in in China!

    As for me, you can see my holdings here:

    http://boards.fool.com/Profile.asp?uid=214846910

    Tim Hanson

  • Report this Comment On February 02, 2009, at 12:33 PM, saving4life wrote:

    pondee619 needs to improve the reading skills

  • Report this Comment On February 02, 2009, at 12:48 PM, pondee619 wrote:

    "pondee619 needs to improve the reading skills"

    Yeah, I guess I was too busy looking for "Why I'll Make Money in China." Mea Culpa. I didn't realize that it was as easy as buying AOB and Global Gains.

    But, since my reading skills are poor, please someone tell me, why will the author make money in China? Other that buying Global Gains.

  • Report this Comment On February 02, 2009, at 12:56 PM, TMFEdyboom223 wrote:

    Tim,

    You're such a Jive Turkey! :-)

    Best Wishes

    edyboom

  • Report this Comment On February 02, 2009, at 1:10 PM, TMFMmbop wrote:

    Hey now, no one called anyone a J-T!

    Tim

  • Report this Comment On February 02, 2009, at 1:11 PM, TMFMmbop wrote:

    Pondee,

    The lesson here is supposed to be that you'll make money in China only if you're willing to do some extra legwork and look where others won't. That means not at the big SOEs (or the FXI ETF that seems to be so popular), but at the entrepreneurial companies that are building brands in China and building lasting competitive advantages rather than temporaray comparative advantages such as a low-cost structure.

    Tim

  • Report this Comment On February 02, 2009, at 1:19 PM, catoismymotor wrote:

    “China is run like an organized crime syndicate. I would no more trust a Chinese company with my money than someone that calls himself Fat Tony.”

    Tim,

    I wrote that. After I submitted it to the comments section I started to question just how much I really believed what I had written. How true it could be? My initial opinion was formed over the summer. I watched a lengthy show about China that was featured on PBS just before the start of the Olympics. One portion of the program specifically covered what it is like to conduct business in China from the point of view of business people with a western philosophy and that of the Chinese. I have to admit that is soured me to the idea of placing my money with a Chinese company for all the reasons listed above.

    Since the Fat Tony reference I have been doing some homework on Chinese companies. I have found two that I favor: China Fire and Security Group (CFSG) and KHD Humboldt Wedag Int. Ltd. (KHD). Both appear to have a solid foothold, good numbers and a potential to have tons of business flow their way. KHD is my favorite of the two. It is based out of Hong Kong, Has been around since the 1950 (British rule! Oy!), and is trading for less than cash on hand.

    And lastly, you quoted Buffet, “Be greedy when others are fearful." I believe that many of us are not fearful of China. It is that we do not entirely trust her. She is still Communist. She still writes the rules in No. 2 pencil. And she is still of a cultural mindset that we don’t entirely understand. Buffet does not invest in companies that he does not understand. I believe that many of us feel the same from a cultural perspective.

  • Report this Comment On February 02, 2009, at 5:23 PM, whambamtymaam wrote:

    Why would you want to invest in China? At a time like this when there is a shortage of investment capital in the US I'll concentrate my energies on companies in the US. I'm sure if you reconsidered and did your homework you could find a better risk and be contributing to the economic recovery in the country where you set foot in the morning. Don't waste your time with articles that shouldn't be written.

    ...reminds me of a realization I had after 9/11... living on the west coast many of the people here really didn't feel the impact.

  • Report this Comment On February 02, 2009, at 5:45 PM, Seano67 wrote:

    "And lastly, you quoted Buffet, “Be greedy when others are fearful." I believe that many of us are not fearful of China. It is that we do not entirely trust her. She is still Communist. She still writes the rules in No. 2 pencil. And she is still of a cultural mindset that we don’t entirely understand. Buffet does not invest in companies that he does not understand. I believe that many of us feel the same from a cultural perspective."

    Great point. I mean let's be realistic regarding China- despite the opening up of its markets, it is still very much an authoritarian state, and one which can and will change whatever rules it sees fit to change whenever it sees fit to change them, regardless of what that might do to investors or anyone else.

    For example, if the sh*t hits the fan over there (as many geopolitical analysts think it might), due to this very large population of people suddenly made unemployed and displaced all over again, well then in my opinion all bets are off regarding China- because they could once again crack the whip and bring the boot to bear at any time.....and then how safe an investment is that?

    When discussing investing in China, I think it's imperative to look at the whole geopolitical picture involved there, not just the individual companies one might be interested in.

  • Report this Comment On February 02, 2009, at 6:28 PM, afleetfeet wrote:

    I have to agree with whambamtymaam. Why invest in China when there is gobs of money to be made at home? U.S. stocks are so cheap right now, it's like winning a free shopping spree at Tiffany.

  • Report this Comment On February 02, 2009, at 6:30 PM, johmsen wrote:

    I bought 500 shares of AOB the first go around, just a few days ago I bought 300 more. I have confidence in this stock and do think it will make me money. The price is great and I think the Motley brothers would not be buying it if they did'nt think the same thing.

  • Report this Comment On February 02, 2009, at 6:30 PM, TMFMmbop wrote:

    catoismymotor,

    Thanks for circling back. Glad to hear you've decided to give China chance, and thanks for the quote.

    Tim

  • Report this Comment On February 02, 2009, at 7:01 PM, 181736065 wrote:

    Check this out...

    UGPIX - approximates double the BKCN. Instant diversification and leverage.

    Bill J.

  • Report this Comment On February 02, 2009, at 11:27 PM, kayakmastr wrote:

    I think the point is that China should be part of any portfolio, but not the entire portofolio, and GG will help you find companies to invest in. Each investor can decide on the percent to invest from their resources, but I think 0% ignores great opportunities. Any stock investment requires trust in the management irregardless of the country. And as been pointed out, not all US companies are exemplars on this issue. I am impressed the MF and GG personnel actually talk to the management of Chinese companies and provide us with relevant info!

  • Report this Comment On February 03, 2009, at 3:15 AM, OldEnglish wrote:

    China Fire and Security Group - Very questionable. See the Sharesleuth article. Don't do it.

    AOB? No. Great growth achieved by perpetual share dilution combined with acquisitions... followed by bankruptcy in eight years. The market for rhino horn, tiger testicles and other "traditional" cures can't be that good in a recession.

    There is nothing, absolutely nothing, protecting your investment in China if we end up playing protectionist games. Stimulous protectionism, currency delvaluation games, maniacal T-bill printing. There are many ways the US could get into an economic conflict with China and American investors will be an easy target.

    Going by the numbers, FEED, is a great company. But it isn't because the management is either hopelessly incompetent or thoroughly corrupt. (Both). Very few numbers coming from Chinese companies can be trusted.

  • Report this Comment On February 03, 2009, at 8:25 AM, lahalsa wrote:

    I am new to the "managing my own" investment game and have had a blast watching, studying, learning, and BUYING!!! Of all the companies I've studied (and bought), I just love AOB!!! I still have a lot to learn about understanding financials and all that...but I'm hungry to learn and am even thinking about taking a couple of classes because I find the whole process fascinating!!! - And fun! I purchased AOB several months ago and have been just dying to buy more - since the stock has been trading for .30-60 cents less per share than when I made my purchase. The problem is, I try to stick to the 5% of my portfolio rule and AOB is already a tad over that "rule." Dang it! I say BUY, BUY, BUY. I am not going to NOT buy - JUST because its China.

  • Report this Comment On February 05, 2009, at 7:22 AM, MrBear509 wrote:

    Is anyone besides me in QXM? This company has more cash per share than its price per share. The company is chasing China Mobile, has great products, and is growing rapidly. Does someone know something I don't?

  • Report this Comment On February 06, 2009, at 3:38 PM, manta40 wrote:

    I bought a Chinese stock GSI last year. I liked what it made and that it was so necessary for the country to build infrastructure.It is also privately owned but sanctioned by the government Any oinions on this stock, It's down to 2.7

  • Report this Comment On February 06, 2009, at 8:23 PM, Scones wrote:

    SUTR is a Chinese play that will boom when the infrastructure money begins to roll in. Great value play with a monstrous future ahead, in my opinion.

  • Report this Comment On February 06, 2009, at 9:10 PM, danechatani wrote:

    Message from downunder...

    Firstly I would like to say there's merit in many of these emails...and worth consideration

    As a country that feeds china's hungry appetite for primary resources....there is much to be wary of and watch this space as we aid and abet this country's coffers.

    Due to the resources plummeting prices largely due to sharply lowered demand.

    China and Japan are in, what they think, a very good position to acquire superior assets ...and quiet rightly...eg: Rio Tinto's selling $20B AUS worth of assets to Chinalco.(A COMPANY TO WATCH) to pay off some debt from buying assets in the boom.

    They will also try and determine the real primary resource price and drive it down based on demand levels...however to that china has used up all it's stockpile of iron ore... so that's a positive.

    (quietly I'm extremely surprised our new prime minister Rudd and his government have not put a halt for further investigation as previously done last year with other M&A's from china...as he said we are into global competitiveness though not global takeover as China has a firm eye on ownership of our resources)

    USA should also be leary as China owns more of your dollars than your federal bank does...hence it's need to keep the dollar propped so firmly.

    I believe the BRIC nations are wonderful buying opportunity ..though I believe there is more downturn to come as nowhere are we seeing signs of an upturn...better to wait and get in on it on the upturn...as the knife is still falling.

  • Report this Comment On February 06, 2009, at 10:17 PM, catdancer40s wrote:

    Tim:

    I get your point about what the Madoff scandal must look like overseas. America's failure to insist on basic truth in lending from our local banks can't look good either. It's not a new thought to me either. The Chinese are truely shocked in America's failure to provide the one product it's known for: Basic reliability.

    But are you trying to draw an equivalency? If you're going to issue an opinion about the overall reliabilty of accounting in a govenment controlled market, I'd like more facts than Madoff did it too. Are you saying basic GAAP is honored in China? That there are controls in place to resist the urge to pump up your stock? Or would things go the way of Chinese schools in an earthquake?

    None of your arguments address any quantitative measure of how comparable their accounting practices are to US/EU. Without some factual point of relative comparison your point seems ill-formed and less than responsible to me.

    You're missing the , let alone the utter lack of transparency with regard to how many .must look like

  • Report this Comment On February 07, 2009, at 11:27 AM, CIDWAL wrote:

    HOW ABOUT CICHF? DO YOU THINK I SHOULD BUY MORE SHARES AS IT'S DOWN TO WHAT I PAID A YEAR AGO?

  • Report this Comment On February 07, 2009, at 1:31 PM, ashesoftime wrote:

    “China is run like an organized crime syndicate. I would no more trust a Chinese company with my money than someone that calls himself Fat Tony.”

    I guess you would rather to invest your money to someone who calls himself Ken Lewis or Bernard Madoff or (do I have to name them for you?)

    It seems that everywhere else in this world is thinking "US is run like an organized crime syndicate." at least in financial terms.

  • Report this Comment On February 08, 2009, at 8:43 AM, fastman01 wrote:

    I do some selling of fasteners to Chinese manufacturers, when usually, for a very small American company, it's the other way around. I talk with a few buyers when they place purchase orders,to get their personal insights into China's overall economy.

    Like most average working people everywhere they only know just so much information about the "big picture", but more on their local situations.

    Known them for 9 years now, and they are sometimes optimistic, and other times not so happy about what's going on in their country.(Sound familiar?)

    A week or so I spent about 20 minutes talking to one of these purchasing agents, and the gist of it was that China will not be growing as fast in 2009 as expected, for various reasons, by about 50% less.

    Huge unemployment, a drop in exports, increased imports, and an infrastructure that needs rebuilding far worse than we here in the US do.

    Actually, China doesn't have much of an infrastructure in the first place, so it's not really rebuilding, but rather it's building an infrastructure.

    China is faced with huge economic problems, just as we are; however, due to it's giant size, their problems effect more people.

    I was told that their government was not pulling any punches, and that it is still very much a Communist system despite it's "free market" feel, and the fact that it now has a "middle class."

    It seems that before the Olympics, the construction business was booming, and now it's almost stopped, except for some few select projects.

    That means that thousands of private building projects stopped almost over night, because money to carry on dried up.

    Thus the huge increase in unemployment.

    The country needed 10 million additional new jobs a year just to break even so to speak, and now it's really in the red, job wise. It's newly created middle class is losing jobs at a good clip, and they are living on credit cards for the most part.

    Then there are the environmental issues it is facing.

    Goods from China are cheap because it has a huge labor pool that will work for next to nothing, and zero pollution standards. Now those situations are changing a bit, at least in the minds of the middle class.

    Millions there is stating to get angry that their rivers are toxic dumps, their air quality is crap, and their natural resources are being raped in the name of progress.

    For it's part the government has created various departments to deal with the situations, but they are paper tigers at best having no funding, little or no staffing, and no real authority.

    China is so darned huge in area that it takes years for something bad that happens in its northern section to be felt in its south.

    As an example, in order to create some huge operations, the government began destroying centuries old natural grasslands that had protecting them from seasonal dust storms off the Gobi desert.

    No protection from those storms way up in the north equals millions of tons of dust finally reaching the south. On good days the big cities in the south look like Los Angeles CA skies on its worst days, only on steroids.

    Also complications from displacing a few million people along the routes of government projects, and taking their lands (again, in the name of progress) has left its big cities filled with homeless, unemployed, hungry, angry people.

    Oh sure, all those people were given literally a few dollars for their lands, and told that they would be moving into brand new resettlement projects; however, that hasn't happened except for a few housing projects that the government shows to the media as just how unfounded all the rumors are that it hasn't done anything.

    So, China has a huge middle class that won't/can't work for a bowl of rice anymore, and a huge & growing class of poor people that has no food because they were removed from their family lands, and a world that is buying less of its products.

    And, somehow, all those people still need to eat, get medical services, and everything else that one needs to live.

    Sure, China has been financing most of our fiscal follies, and it has tons of notes from us, but make no mistake about it, China needs the US just as badly as we need them, perhaps more so because it is so much larger.

    All the talk about protectionism and retaliation, and blah, blah, blah, is just saber rattling by both sides.

    The real authority in China is it's military, but it's salvation is going to come from it's entrepreneurs.

    Most of the business movers & shakers are extremely well educated, and understand how to make money.

    Make no mistake about it, the newer politicians know how the game is played, perhaps better than anyone else.

    This new breed of leaders is going to be replacing the old guard, and they will use everything in their power to continue China's forward progress.

    So not owning a piece of China's emerging economic future makes no sense.

    What to buy, and when to buy it, I haven't figured out yet, and I might not get involved in it until Q4 of 2009.

    The same goes for India. There is money to be made there also, but how to begin getting involved, and what to get involved in, I don't know.

    Right now, and for the next 10 - 12 years, the US is still going to be the power that drives the world's economic engine, and then we will share more and more of that responsibilty with China & India.

    Or, perhaps it will happen sooner, but happen it will.

    Maybe President Obama can get the major countries all back on the gold standard, and everybody will stop this foolish fractional reserve banking system nonsense that has wrecked the world's economies. He might need 3 terms in office to do that. Hahahaha!!!

  • Report this Comment On February 09, 2009, at 7:02 AM, indiobravo wrote:

    Some of you guys mention that stocks in US are cheap and they are a great opportunity. But, how long will those stocks remain cheap?

    If you are 35 or older you will never see most of banks and financial services stocks recover the price of 2006. The Great Depression bear market lasted for more than 10 years, and the nation were young and strong. Now US is a "senior citizen nation" (I am not talking about the people, I mean the nation itself) and you should realize that this pain will remain to the end. Yes, the end.

    You may invest in China, and India, and Europe, and Latin America. Or you can invest in US and wait for a miracle.

  • Report this Comment On April 29, 2009, at 2:56 AM, glenn12345 wrote:

    QXM: Does someone know something I don't?

    Uh, yeah. Look at their related party transactions (for XING and QXM... same bunch of people). Insiders basically use this company to make themselves richer, shareholders be damned.

    XING insiders were sued by its shareholders over cooking QXM's book to IPO it higher. This was settled for $2.4 million but insiders had the company pay for it.

    XING's acquisition of one insider's company is also a terrible, terrible deal. XING should have been buying back its share considering XING had an insane price/book ratio and P/E. This is a money trap.

    But the underlying business is (IMO) very good and should have earnings growth... so if you're feeling lucky, you could try to hit it and quit it. Whether reported earnings grow is another story!!!

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