The Investment Opportunity of a Lifetime

If you've never followed George Soros, now is the time to reconsider. 

See, he's spent nearly 50 years studying boom-bust cycles, including the international banking crisis, the collapse of the British pound sterling, and the Asian financial crisis. He's made billions both on the upside of those bubbles, and during the panic on the downside.

In fact, he predicted that a housing crash following years of overspending would fuel a severe recession. Soros emerged from retirement to earn a 32% gain in 2007 and a positive return in 2008.

Given the severity of like the currently collapsing housing and credit bubbles, and Soros' profit-making track record in crises like these, we would do well to ask him what opportunities he sees today.

The short answer: China
In his book The New Paradigm for Financial Markets, Soros reveals that during his visit to China in late 2005, he "saw greater opportunity than at any other time in my career." He called China -- with its rapid GDP growth and the potentially lucrative privatization of state-owned-enterprises (SOEs) -- "the opportunity of a lifetime."

Last year's sell-off in emerging market stocks hasn't changed his mind. In a recent speech at Fudan University, he said he believes "China has been recovering, and its pace of recovery will be faster than the rest of the world."

And that means the opportunity to buy Chinese names like Baidu.com (NASDAQ:BIDU) and LDK Solar (NYSE:LDK) at cheaper valuations than Soros was touting in 2006 won't last long:

Sources: The Economist, Yahoo! Finance, and Capital IQ, a division of Standard & Poor's.
*China-, Hong Kong-, and Macau-domiciled stocks capitalized at more than $100 million and trading over major U.S. exchanges.

So what has Soros so interested in China? It's largely the same money-making trends he saw in the U.S. during the 1980s.

How it went down here
Between the mid-1970s and the mid-1980s, the combination of high interest rates and an oil shock led to a long period of stock undervaluation. From 1977 to 1984, the S&P 500 mostly traded between 6 and 10 times earnings -- the average P/E since 1936 is nearly 16.

This phenomenon resulted in a number of highly profitable, undervalued cash cows. An acquiring company could sell shares or borrow money to purchase these cash cows on the cheap, and then use the acquired cash flows to pay down debt or sell more shares -- ultimately increasing its own net worth.

Some of the larger deals at the time included General Electric's (NYSE:GE) multibillion-dollar deal for NBC, Southwest Airlines' (NYSE:LUV) acquisition of Muse Air, and PepsiCo's (NYSE:PEP) purchases of Pizza Hut and Taco Bell (now owned by Yum! Brands (NYSE:YUM)). Each of these three companies appreciated several-fold during that time.

How it will go down there
There are currently around 100,000 Chinese SOEs (about one-third as many as during Mao's time), many of them inefficient and unprofitable. To promote efficiency and economic growth, the government forces them out of business by barring state-owned banks from lending them money, or by simply transferring their assets to more efficiently run subsidiaries.

In short, companies with superior managerial skills and access to capital can swallow poorly run companies for a tiny fraction of their true worth, turn them toward profitability, pay down their debt or issue new shares, and repeat the process.

And a market environment that is adding pressure on the least-profitable SOEs is only accelerating this phenomenon. The result is one of the fastest-growing economies in history -- and the winners have largely been predetermined.

What to look for
Soros points to what he calls "super state-owned-enterprises," spinoffs from state-owned enterprises, which are: 

• Well-managed.
• Run by motivated leaders.
• Blessed by the government.
• Able to access parent company assets.

That's astonishingly close to the conclusion our Motley Fool Global Gains team reached upon returning from their second trip to China. Advisors Tim Hanson and Nathan Parmelee recommend a number of "state-sponsored enterprises," their terminology for companies with:

• Good management.
• Motivated entrepreneurial leadership.
• Government backing.
• Access to capital.

Here's a name
When our team visited Chinese pharmaceutical maker American Oriental Bioengineering (NYSE:AOB) at its Harbin headquarters, management told them that the government is working hard to reduce the number of drug companies in China, which currently number more than 3,000.

AOB's strategy has been to raise capital in U.S. markets and purchase SOEs at massive discounts. That strategy is paying off -- overall sales grew more than 50% this past year.

So remember the advice of Soros and our Global Gains team for what may be the investment opportunity of our lifetimes: well-managed Chinese SOEs with motivated leadership, government backing, and access to capital.

If you're looking for some more stock ideas, you can check out Nathan and Tim's favorite stocks from their travels to China, as well as our top 10 international stock ideas, free for the next 30 days. Just click here to get started. There's no obligation to subscribe.

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Ilan Moscovitz owns shares of American Oriental Bioengineering, a Motley Fool Hidden Gems recommendation, Global Gains pick, and Motley Fool holding. PepsiCo is an Income Investor selection. Baidu.com is a Rule Breakers recommendation. The Fool has a daredevil disclosure policy.