ETF Teardown: China's Best Stocks

Noted for their simplicity, ease, and flexibility compared to mutual funds, exchange-traded funds have become a popular investing tool. Like funds, ETFs hold a collection of stocks that share certain elements in common. For example, if investors want to capitalize on the booming economy in China, they can turn to iShares FTSE/Xinhua China 25 Index or PowerShares Golden Dragon Halter, which track two different Chinese stock indexes.

But since these ETFs invest in a number of stocks, their broad diversity also limits your upside. For an investor who's, say, really hip to energy companies in the region, but cold on the future prospects of Chinese Internet stocks, these ETFs wouldn't fit the bill.

Fear not, Fool. In this edition of "ETF Teardown," we'll drill into the best stocks China has to offer. To help, we'll use Motley Fool CAPS, our tool for screening and ranking stocks and stock-pickers.

The power of tags
To help investors quickly locate great stocks, the more than 4,900 stocks CAPS rates can each be "tagged" with descriptors that group the company with others sharing certain qualities -- "alternative energy," for example, or "South Korea."

Selecting the "China" tag in CAPS brings up 76 Chinese investments -- including the iShares FTSE/Xinhua China 25 Index -- that trade on American exchanges. This particular collection of investments has done well in the past year, up 28.8% versus the S&P's gain of only 11.9%.

To gauge which companies the CAPS community thinks are China's best opportunities today, we can sort this list by star rankings. CAPS investors' collective opinions award each stock a rating from one to five stars, with five being the best. We can also see exactly who -- from Wall Street to Main Street -- is bullish or bearish on the each company, and why.

Getting down to the nitty-gritty
The last time we looked at favored Chinese stocks, we had a large group of five-star stocks to consider. That hasn't changed, with 25 top-rated stocks in our latest lineup. Here are a few of the five-star stocks our screen pulled up today.

Core infrastructure industries -- such as those related to the supply of raw materials, fuel, and construction -- continue to rank among investors' favorite plays in China. With an almost insane level of construction going on to prepare for the 2008 Olympics, as well as the influx of more skilled workers to urban areas, companies such as Aluminum Corp. of China (also known as Chalco) and PetroChina have been riding a huge wave of demand. In the first half of 2007, PetroChina's natural-gas output shot up 16.5% from a year ago. The company expects demand to continue rising through the balance of the year. To meet the demand for oil and gas, PetroChina will be outspending other global oil giants ExxonMobil (NYSE:XOM) and BP to increase production capabilities.

Surging demand for energy has also bestowed favor on a Chinese alternative-energy provider Suntech Power. The company takes advantage of low-cost manufacturing techniques and inexpensive labor to make solar power a viable economic alternative across a range of applications. With petrochemical concerns struggling to keep up with global demand, it stands to reason that photovoltaic (PV) cell manufacturers stand to benefit as well, particularly in a world becoming more focused on renewable energy. More than 1,360 investors in CAPS agree, betting that Suntech will light up the S&P going forward.

Moving further down the food chain, investors have taken a strong liking to Internet gaming provider The9, one of many companies enticing millions of Chinese online to play interactive games. The company's exclusive license for China's version of the hit game World of Warcraft has kept the yuan flowing, to the tune of $34.5 million in the first quarter of this year. But beyond this success, the company is rapidly diversifying its game offerings to alleviate concerns that it might be relying too heavily on Warcraft. CAPS investors largely believe the company will thrive on a multiproduct base, since bulls here outnumber bears 35 to 1.

You can lead a horse to water ...
Plucking individual stocks from an emerging market such as China is always risky. Investors should perform their own due diligence on companies, rather than blindly taking anyone else's recommendation. After all, even the best stock-pickers can guess horribly wrong sometimes.

Do you agree that energy or metals are still the best places to be in China? Or are Chinese gaming companies a better play? Give your own opinion in Motley Fool CAPS.

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Fool contributor Dave Mock loves doing the teardown part -- it's the put-back-together part he hates. He owns shares of ExxonMobil. Dave is the author of The Qualcomm Equation. Suntech and NetEase areRule Breakers recommendations. The Fool's disclosure policy soars like a wuxia warrior.