China is booming. You probably knew that from reading the reports in American papers every day, but even those don't do the story justice.
Beijing and Shanghai are vast, well-planned cities bursting with commerce. Cars clog the roads, and as many cranes dot the skyline as skyscrapers.
Packed ferries depart Hong Kong for Macau some 50 times daily. A consumer class is finally starting to emerge in China, and these folks are looking to spend. According to research by Roth Capital, China's middle and luxury classes now number some 300 million. That population matches that of the entire United States. It's no wonder Wynn Resorts
Why China is ready to roll
With so much money having already flowed into this hot market, investing in China now can be a scary prospect. After all, the worst results occur when people overpay to chase returns.
But that's not the case in China, says Roth Capital's Director of International Research Gordon McBean. He's working in Shanghai writing research on Chinese small caps, and in his words, "It's not even the seventh inning."
To prove his point, he notes that most industries in America are already dominated by large players. McDonald's
We're just getting warmed up
In China, it's a different reality. Each one of these industries -- and many more -- have fast-growing small companies with clear first-mover advantages that also have just 3% market share. That means there's enormous potential in the stocks.
And while the big Chinese cities such as Shanghai and Beijing are already very wealthy, the government's planned westward migration should bring amazing opportunities to smaller cities such as Xi'an. That means more market share for established small players, and the prospect of sustained 25% or more annual top-line growth.
That's right: sustained 25% or more top-line growth.
But small caps in China can also be a dicey proposition. As Mr. McBean points out, "You have to take extra steps in due diligence here." That can be as simple as making sure a company has a good auditor and strong legal counsel, and it can be as time-consuming as going out to kick the tires at the company's headquarters and getting the lay of the land from its customer's customers.
But that's not all...
Mr. McBean also had one last piece of advice for any American retail investor who's looking to make a killing in China. And it's the key to it all -- particularly if you're looking for growth. He was happy to share it with us.
The only small Chinese companies that will be able to sustain high levels of growth are those that will dominate the niche in which they operate. For that to happen, they need the government to leave them alone.
Even though the Chinese economy is liberalizing, the Chinese government continues to operate in industries that it's deemed to have strategic importance through state-owned enterprises (SOEs). These firms receive tacit support from the government and will not be allowed to fail.
In other words, private companies that try to compete with them will never win the market, no matter how efficiently they operate. So Mr. McBean's advice is "stay away." Companies that compete with SOEs simply don't have the upside potential of the rest of the economy.
Weed out the wannabes
Thankfully, despite that restriction, there are still hundreds of promising Chinese small caps for you to invest in -- many of which trade on U.S. exchanges. Global Gains advisor Bill Mann, analyst Paul Elliott, and I have met with a few of them during our stay in China these past few weeks and gotten the scoop on many more -- and we still have a few days left to cover! We'll also be following up with more analysis when we get home.
After all, there's so much to tell about China's economic story that it's nearly impossible to do it justice.
Tim Hanson owns shares of Wynn Resorts. The Motley Fool's disclosure policy recommends that when arriving in Chinese ports of call, you arrange your transportation to the hotel ahead of time.
