Let me be straight with you: I didn't own a single Chinese stock prior to 2008.
You may think that's shocking, considering I'm the co-advisor of our Motley Fool Global Gains international investing research service. But prior to 2008, Chinese stocks were very expensive. That didn't stop many American investors, smitten with these stocks' momentum and potential for growth, from buying them up.
Today, I own sizable chunks of five Chinese stocks, including at least one you might tell me is insanely risky. But these stocks have been crushed, and they now look quite cheap relative to their growth potential.
Of course, now most American investors won't touch these stocks with a 10-foot pole.
Or even a 20-foot pole
If you read this recent column, you know I'm less skeptical than most of a recent $70 million property acquisition by a Chinese company called American Oriental Bioengineering. In fact, I believe the acquisition will yield important economic benefits.
Yet since that acquisition, investors have shaved more than $180 million off AOB's market cap. That's more than twice the amount of cash that came off the company's balance sheet to buy the property, indicating that American investors actually think that with this infrastructure purchase, AOB is reducing the value of its core business.
But if you look at AOB's financial statements, you'll see a fast-growing company that's generating gobs of free cash flow. So why would investors think that a building purchase is destroying shareholder value?
Frankly, they think China is a fraud.
I realized this the other day when ...
I went back to check the comments from readers at the bottom of that AOB column, and here's what I found they were saying:
"To be a successful investor in China, you must be an insider. Pretending there is western-style transparency in the market is a folly.... Be prepared to pay a lot of bribes and don't be surprised if some of the people you bribe end up dead."
"The only companies worth investing in China are China Mobile, CNOOC, PetroChina, and Sinopec."
"Subjecting Chinese companies to the same forms of analysis as you would a U.S. company is unrealistic. I wouldn't buy Iranian government bonds either. These are countries that make up written rules as they go along and abide by some very old unwritten rules that only apply to insiders."
And my personal favorite ...
"China is run like an organized crime syndicate. I would no more trust a Chinese company with my money than someone that calls himself Fat Tony."
You get the point
Look, I'll be the first to admit that China is not all raindrops on roses and whiskers on kittens. But writing off the world's most populous nation and third-largest and fastest-growing economy as a criminal enterprise strikes me as ill-informed. As Warren Buffett has said, "A public opinion poll is no substitute for thought."
China's growth potential is tremendous, but if you're going to invest in the country, you shouldn't do so with blinders on. That's true no matter where you invest.
After all, here in the United States over the past year, we've had the Madoff scandal, the collapse of a housing industry whose growth was fueled by the questionable practices of people like Franklin Raines and Angelo Mozilo, and billions upon billions of dollars’ worth of asset writedowns at once-proud institutions. Heck, one of the causes of this whole ordeal was a product widely referred to as a "liar's loan."
No matter where you invest, you are not immune to fraud, greed, or management teams that are not acting in your best interests. And yes, there are management teams like that in China. The important point is that it's not all of them. You can succeed by finding the good ones and diversifying your portfolio appropriately.
At Global Gains, we’ve recommended that our members buy a basket of Chinese stocks with exposure to three key themes: the rise of the middle class, increased consumption of commodities, and continued infrastructure development. If you take that advice, you might look at these groups of stocks:
The rise of the middle class
Increased consumption of commodities
Continued infrastructure development
New Oriental Education
China BlueChemical, CNOOC, PetroChina, Zhongpin
Hang Lung, Jinpan International
Another Buffett quote is applicable here: "Be greedy when others are fearful." All you have to do is reread the comments I cited to see that individual American investors are running away from Chinese stocks en masse. That means promising opportunities are being left behind.
I've made it my mission to find those select China opportunities, and I'm doing so through careful research, meetings with management teams, learning the language, and visiting the country as frequently as possible. That's why I believe I'm going to make money in China over the long term.
If you'd like to join me, you can sign up for a free 30-day trial of Motley Fool Global Gains and get all of the notes from our upcoming research trip to China and company visits. Just click here for more information -- there's no obligation to subscribe.
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This article was first published Feb. 2, 2009. It has been updated.
Tim Hanson is the co-advisor of Motley Fool Global Gains. He owns shares of AOB. AOB is a Motley Fool Hidden Gems and a Global Gains recommendation. New Oriental and CNOOC are also Global Gains picks. Jinpan is a Hidden Gems selection. The Motley Fool owns shares of AOB. The Motley Fool has a full disclosure policy.