It's been two weeks since our Motley Fool Global Gains team returned from China and folks have been asking about what we found. As with all of our trips, we learned a lot, but the key insight this time around is that after 30 years of better than 10% GDP growth -- and having lifted more people out of poverty than any other nation in history -- China has reached a moment of truth. In fact, aside from Deng Xiaoping's initial experiment with Special Economic Zones (SEZs) in 1978, this may be the most important turning point in China's economic history.
But before we can talk about what this means for China and investors, you need to know how China got here.
Some background
China's past three decades of economic success have largely been built on the back of one business model: low-cost manufacturing. The country was the world's factory, churning out exports by the ton and becoming the world's largest exporter in turn.
This, however, is unsustainable. Not only are the large consumer markets that China has long sold to, notably the United States and Europe, seeing reduced demand, but rising wages and property prices, domestic and foreign demand for a stronger currency, and the emergence of other low-cost manufacturing centers in Southeast Asia are all eating away at China's cost advantage. This has prompted some Chinese manufacturers to move from the coast to China's interior, where wages are lower and government incentives for development available -- but these are unsustainable stopgap measures.
This is why it's worth avoiding companies such as Cogo Group (Nasdaq: COGO ) , Deer Consumer Products (Nasdaq: DEER ) , and others that have succeeded on the premise of low-cost Chinese manufacturing. Even a company such as SinoHub (Nasdaq: SIHI ) , which has built a fascinating little business on the back of manufacturer supply chain management, could find itself on the wrong side of history if its customers and/or suppliers in China struggle.
But there is a way for China to continue its economic development and eventually surpass the U.S. as the world's economic superpower -- and one that should make good money for savvy investors along the way.
Why the government is along for the ride
Of course, nothing happens in China without an assist from the government, so an important question here is whether China's government is ready to push forward with an economic transformation. We believe it is because our thesis has long been that the Chinese government's overarching goal is to maintain control. This is one reason why the government has been willing to compromise traditional Communist economic ideology in the past in order to achieve faster economic growth. Economic growth means employment, rising wages, and higher standards of living -- all things that can keep a population content not to rise up.
A consequence of this is that the rising generation of Chinese workers have higher expectations than any generation before them. As analyst Louis-Vincent Gave has written, this means that China can no longer grow by "squeezing labor," and given the government's desire to keep people happy, the corollary here is that it is no longer willing to be the one to squeeze labor. It's against this backdrop that many of the government's recent policy enactments make perfect sense -- and point to the development of a very different China going forward.
Where China is headed
When the government wants something to happen in China, it generally happens, which is one reason why tacit government support is a prerequisite for our investing in any company or theme in the country. And while we've held off in the past from recommending Chinese consumer stocks, citing better opportunities in agriculture and infrastructure development, our recent journey convinced us that China's government is finally ready to stoke a consumer revolution.
With economies slumping around the world, China's economic march now depends on boosting personal income, demand, and consumption domestically -- with top leaders admitting as much publicly. This is why the People's Bank recently announced its willingness to allow China's currency to strengthen, why the government is putting in place a health-care safety net, and why the government has been happy to subsidize the purchase of big-ticket consumer goods.
Today, with consumer stocks down, the Chinese government stimulating spending, and Chinese consumers sitting on $2 trillion in spending power and virtually no debt, the sleeping giant of Chinese consumerism is about to wake up. That's why we came home with four stocks to profit from this megatrend, companies either with strong consumer appeal or that are tied to nationwide branding efforts in the country, and I'd like to share one of them with you right now.
One China consumer pick
You probably already know Yum! Brands (NYSE: YUM ) from the thousands of KFC, Pizza Hut, and Taco Bell restaurants that it operates in the United States. But did you know that Yum! has also already won over the hearts and stomachs of Chinese diners? KFC is one of the country's most popular fast-food brands, much more so than either McDonald's (NYSE: MCD ) -- which has one-third of Yum!'s locations in the country (though is investing heavily) -- or Starbucks (Nasdaq: SBUX ) -- which is (and is considered) too expensive for the everyday Chinese consumer.
Although Yum! already has almost 3,600 locations in China (again, triple McDonald's), that number pales next to 20,000 -- the number of locations it has in the U.S. and that it expects it can open in China. In other words, while Yum! is already established in China, it also has a lot of room to grow, which is a very nice combination for long-term investors like us.
Tack on a 2% dividend, experienced and shareholder-friendly management, and an established global business that will help even out China's volatility, and Yum! is as close to a no-brainer as one can get when it comes to low-risk exposure to the Chinese consumer.
Yet Yum! is just one of four stocks you should own as part of your own mini-mutual fund to profit from the rise of the Chinese consumer. To learn about the other three, simply click here to join Motley Fool Global Gains free for 30 days and download your copy of our newest report, Rise of the Chinese Consumer: 4 Stocks to Profit From China's Next Big Trend.
RSS Headlines
Fool UK