The Danger of Overpaying for These Stocks

It has become very clear that investors who continue to ignore foreign stocks will be missing out on the greatest growth stories of the next couple of decades. The growth and diversification benefits are such that Wharton finance professor Jeremy Siegel says U.S.-only investors are practicing a "risky strategy."

But there is also a danger in jumping into foreign equities at any price, particularly in the richly valued Chinese market. Siegel, Buffett, and common sense will all tell you that. Fortunately, there is a way to buy into the massive growth of the Chinese economy without overpaying, and I'll tell you how by the end of this article.

But first ...
Consider this: U.S. stocks accounted for 90% of the world's equity capitalization at the end of World War II, but by 2050 they will make up less than 18% of the worldwide market, according to the U.N. Demographic Commission. Sure, there will be plenty of American success stories in the coming decades, but why exclude from your investing universe foreign wonders like Canadian wireless expert Research In Motion (Nasdaq: RIMM  ) and Brazilian metal miner Vale (NYSE: VALE  ) ? They've blasted the average U.S. stock returns this past "lost decade" with 539% and 913% gains, respectively.

Experts are particularly excited about the Chinese and Indian markets, which Siegel says will move "to the forefront of the world economy." But here's where the danger comes in. Siegel's research in Stocks for the Long Run clearly shows that fast growth does not necessarily translate into superior stock returns, mostly because of high valuation levels. For instance, some of the finest growth businesses in the world were so overvalued at the height of the tech bubble that they went on to lose 70% or more after the bubble popped -- Amazon.com (Nasdaq: AMZN  ) and Intel (Nasdaq: INTC  ) among them.

So, you want to be in the Chinese market, but you don't want to overpay. You want to find the future Amazons and Intels before they get all... bubbly on you. Here's how you can do it.

Tiers for fears
Motley Fool Global Gains advisor Tim Hanson has visited China three times in the past three years, and has come away with insights you won't read about anywhere else. He's advising his members for the time being to stay away from the glitz and glamour of "tier one" China, which is centered on coastal giants such as Beijing or Shanghai. This is the China familiar to most of us, and home to companies such as Origin Agritech (Nasdaq: SEED  ) , Baidu (Nasdaq: BIDU  ) , and JA Solar (Nasdaq: JASO  ) .

Instead, investors should turn to the poorer, rural, less developed tier two and tier three China, which are not only experiencing faster growth than tier one China, but are also home to more reasonably valued companies. Yes, we're talking faster growth at cheaper prices, and Tim is one of the few analysts in the country talking about this opportunity.

Cheaper stocks, faster growth
For the seventh year in a row, the Chinese government says its top focus will be on furthering development and raising incomes in the rural parts of the country. With more government money and manpower pouring in, the fast growth in rural China will continue. Here you'll find, according to Tim, "cheaper stocks, faster growth, and more sustainable economic tailwinds."

If you'd like to know more about which stocks Tim and rest of the Global Gains team specifically recommend, you can do so at no cost with a free 30-day trial of the service. This not only includes all their active recommendations, but also the special report, The China Rural Boom Basket: 5 Ways to Play the Fastest-Growing Niche in China. Here's more information.

Fool analyst Rex Moore finally found where the rubber meets the road. Intel is a Motley Fool Inside Value pick. Baidu is a Motley Fool Rule Breakers selection. Amazon.com is a Motley Fool Stock Advisor recommendation. Motley Fool Options has recommended a buy calls position on Intel. The Fool has a covered strangle position on Intel and a disclosure policy.


Read/Post Comments (5) | Recommend This Article (37)

Comments from our Foolish Readers

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 March 18, 2010, at 10:28 PM, SquaredHedge wrote:

    I worry about China stocks because of the reporting requirements. YUII is a good example of a Chinese company that failed to report some loans and had their auditor resign. The stock was pummeled. Most of the Chinese stocks are commodity plays (food, fuel, metals, etc) as there are no real conglomerates like PG or JNJ. You have to pick your entry points very carefully as the hot money is moving in and out very quickly. Look at the chart of SCOK and you will see what I mean. So while these companies may have more sizzle, the Tier One companies are more reliable. As always, risk vs reward.

  • Report this Comment On March 18, 2010, at 11:13 PM, vdronex wrote:

    CIWT... just what your looking for?

  • Report this Comment On March 19, 2010, at 10:54 AM, Brickguy wrote:

    Amazon.com (Nasdaq: AMZN) and Intel (Nasdaq: INTC) are great stocks for a long time.

    I feel like I shouldn't even tell you about this. But frankly, now that the Navy itself has let the cat out of the bag...http://gold-stocks-investing.blogspot.com/2010/03/investing-...

  • Report this Comment On March 19, 2010, at 3:26 PM, ScottRichard wrote:

    Brickguy--

    I recommend that anyone use extreme due diligence when considering penny stocks such as referenced by the URL in your post.

    The impetus for the URL referenced post seems to be the Cosco geothermal field at China Lake Naval Air Base. The first Cosco well was drilled in 1987 and the geothermal field has been public information for many years. California Energy has been buying power from Cosco for a long time. The "cat" is long dead and the "bag" has become threadbare. I'm always suspicious of solicitations that seem to imply that they have "secret" knowledge.

    I didn't get the free report as I have no interest in the $1,495 superdeal on the $5,000 newletter. However, based on the "Well 56-4" mention, the MI #3 seems to point at Sierra Geothermal stock (SRAGF.FX). If you type "Sierra Geothermal" into the MF search engine at the top of the page you will also discover other small companies involved in geothermal.

    While these small companies are likely credible, just small, information on most penny stock companies is frequently hard to come by other than by requesting their prospectii.

  • Report this Comment On March 21, 2010, at 9:26 AM, sickafus wrote:

    We have stocks in this country flying below the radar,

    STWA, for one...Symbol ZERO, they may end up being a 50 dollar stock. They make thick crude oil flow faster, and various other things in the works.

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