There Is Still Plenty of Opportunity in China

Stock markets around the globe have been extremely volatile in the past two years, but few can match the gyrations of the Shanghai composite. From May 2005, the Shanghai market was up more than sixfold by its high in October 2007. From there, the index collapsed 72% by November 2008.

With the composite now up more than 70% from its low less than a year ago, it's fair to ask whether there is still value in China.

Where valuations are now
The most prominent Chinese index-tracking fund, the iShares FTSE/Xinhua China 25 Index, currently trades at 11 times earnings, which looks like a bargain. But with more than 75% of its holdings in just energy, telecom, and financial services, the index isn't a good measure of value for much of the Chinese stock market.

To get a more detailed look, our Motley Fool Global Gains team has searched all the major global exchanges for Chinese-listed companies and categorized them by median price-to-earnings, enterprise value-to-EBITDA, and price-to-book value. The results as of June 23 are below, along with comparisons to a number of other major markets.

Data provided by Capital IQ, a division of Standard & Poor's. Calculations by Global Gains. EBITDA = earnings before interest, taxes, depreciation, and amortization.

Expanding the universe further shows that Chinese companies are pricier in aggregate than their other international counterparts.

But what this table doesn't show is that the high prices are in pockets of the market, and the priciest China-based companies have a few things in common: They tend to be listed on the Shanghai or Shenzhen exchanges, or they are members of the tech industry.

Search engine Baidu (NASDAQ:BIDU), instant-messaging software company Tencent Holdings, and battery maker BYD all have price-to-earnings (P/E) multiples over 45. In the U.S., we have the same situation with Google (NASDAQ:GOOG) and Qualcomm (NASDAQ:QCOM) sporting P/Es of 30 or more, well above the median of the market.

Plenty of value out there
The Chinese market looks frothy on the surface and some companies are certainly overpriced, but there are plenty of high-quality companies trading at much more reasonable valuations. Of the 3,000 China-based companies on our list, one-quarter have P/Es below 20. Among them are oil and gas firm CNOOC (NYSE:CEO) and Dynasty Fine Wines, a major wine maker in China based in Hong Kong that is part owned by France's Remy Cointreau. Both have solid balance sheets and dividend yields above 3%.

Slightly more expensive is athletic-apparel maker and Nike (NYSE:NKE) competitor Li Ning, but, considering its strong brand and growth potential, it's not unreasonably priced at 28 times earnings. The same can be said for China Mobile (NYSE:CHL), which trades at a very slight premium to AT&T (NYSE:T) and other telecoms around the world.

Even more bargains
The metrics used here are helpful in understanding relative valuations and highlighting companies with potential for above-average returns. But really understanding a company requires more thorough vetting of its industry and business-specific risks, and, if possible, meeting with management, touring operations, and seeing consumers grabbing the products off store shelves.

Our Motley Fool Global Gains team is heading back to China next month to meet with some promising companies we've identified through our research. If you're interested in hearing about what we find, you can sign up to receive all of our free real-time dispatches from the field simply by providing your email address in the box below.