The Investment Opportunity of a Lifetime

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If you've never followed George Soros, now is the time to reconsider. 

See, he's spent nearly 50 years studying boom-bust cycles, including the international banking crisis, the collapse of the British pound sterling, and the Asian financial crisis. He has made billions both on the upside of those bubbles and during the panic on the downside.

In fact, he predicted that a housing crash following years of overspending would fuel a severe recession, and emerged from retirement to earn a 32% gain in 2007 and a positive return in 2008.

Given the severity of the housing and credit bubbles that are now collapsing and Soros' profit-making track record in crises like these, we would do well to ask him what opportunities he sees today.

The short answer: China
In his book The New Paradigm for Financial Markets, Soros reveals that during his visit to China in late 2005, he "saw greater opportunity than at any other time in my career." He called China -- with its rapid GDP growth and the potentially lucrative privatization of state-owned-enterprises (SOEs) -- "the opportunity of a lifetime."

Last year's sell-off in emerging market stocks hasn't changed his mind. In a recent speech at Shanghai's Fudan University, he said he believes "China has been recovering and its pace of recovery will be faster than the rest of the world."

And that means the opportunity to buy names like Mindray Medical (NYSE: MR), China Security & Surveillance (NYSE: CSR), Shengdatech (Nasdaq: SDTH), at cheaper valuations than Soros was touting in 2006 won't last long:

China	2006	2007	2008	Now
Average P/E*	30	34	44	25
SSE Index Returns	130%	97%	(65%)

Sources: Yahoo! Finance and Capital IQ, a division of Standard & Poor's.
*Chinese, Hong Kong, and Macau domiciled companies capitalized at over $100 million and trading on major U.S. exchanges.
SSE is the Shanghai stock exchange index.

So what has Soros so interested in China? It's largely the same money-making trends he saw in the U.S. during the 1980s.

How it went down here
Between the mid-1970s and the mid-1980s, the combination of high interest rates and an oil shock led to a long period of stock undervaluation. From 1977 to 1984, the S&P 500 mostly traded between six and 10 times earnings -- the average P/E since 1936 is around 16.

This phenomenon resulted in a number of highly profitable, undervalued cash cows. An acquiring company could sell shares or borrow money to purchase these cash cows on the cheap and then use their acquired cash flows to pay down debt or sell more shares -- ultimately increasing its own net worth.

Some of the larger deals at the time included Bank of America’s (NYSE: BAC) purchase of Seafirst, Chevron (NYSE: CVX)’s Gulf Oil acquisition, and the Marathon Oil (NYSE: MRO)-US Steel (NYSE: X) merger. Each of these companies appreciated several-fold during that time.

How it will go down there
There are currently around 100,000 Chinese SOEs -- about a third the number as during Mao's time -- many of them inefficient and unprofitable. To promote efficiency and economic growth, the government forces them out of business by barring state-owned banks from lending them money or by simply transferring their assets to more efficiently run subsidiaries.

In short, companies with superior managerial skills and access to capital can swallow poorly run companies for a tiny fraction of their true worth, turn them to profitability, pay down their debt or issue new shares, and repeat the process.

And a market environment that is adding pressure on the least-profitable SOEs is only accelerating this phenomenon. The result is one of the fastest-growing economies in history -- and the winners have largely been predetermined.

What to look for
Soros points to what he calls "super state-owned-enterprises," spin-offs from state-owned enterprises, which are:

• Well-managed.
• Run by motivated leaders.
• Blessed by the government.
• Able to access parent-company assets.

That's astonishingly close to the conclusion our Motley Fool Global Gains team reached upon returning from its second trip to China. Advisors Tim Hanson and Nathan Parmelee recommend a number of "state-sponsored enterprises," their terminology for companies with

• Good management
• Motivated entrepreneurial leadership
• Government backing
• Access to capital

Here's a name
When our team visited General Steel at its Shaanxi facility, management told the team that the government is working hard to reduce the number of steel companies in China, which is around 1,000.

General Steel's strategy has been to borrow money at modest interest rates and purchase controlling stakes in SOEs at massive discounts. That strategy is paying off -- overall sales grew more than 30% this past year.

So remember the advice of Soros and our Global Gains team for what may be the investment opportunity of our lifetimes: well-managed Chinese companies with motivated leadership, government backing, and access to capital.

If you're looking for some more stock ideas, you can check out Nathan's and Tim's favorite stocks from their just-completed research trip to China, as well as our top 10 international stock ideas, free for the next 30 days. Just click here to get started. There's no obligation to subscribe.

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This article was originally published June 15, 2009. It has been updated.

Ilan Moscovitz doesn't own shares of any companies mentioned. General Steel is a Motley Fool Global Gains pick. Mindray Medical is a Rule Breakers selection and a Motley Fool holding. The Fool has a daredevil disclosure policy.