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 sterling pound, 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, and emerged from retirement to earn a 32% gain in 2007 and a positive return in 2008.

Given the severity of the housing and credit bubbles that are now collapsing, 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 names like NetEase.com (NASDAQ:NTES), Suntech Power (NYSE:STP), and Yanzhou Coal Mining (NYSE:YZC) 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.
*Chinese, Hong Kong, and Macau-domiciled stocks capitalized at more than $100 million and trading over major U.S. exchanges.
P/E = price-to-earnings ratio. SSE = Shanghai Stock Exchange.

So what has Soros so interested in China? It's largely the same moneymaking 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 their 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 purchase of NBC, Delta Air Lines' (NYSE:DAL) acquisition of Northeast Airlines, and Dupont's (NYSE:DD) multibillion-dollar purchase of Conoco (which was later spun off and merged to become ConocoPhillips (NYSE:COP)). Some of these companies appreciated several-fold during that time.

How it will go down there
There are currently about 100,000 Chinese SOEs -- about a third the number as during Mao's time -- and many of them are 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 to profitability, pay down their debt or issue new shares, and repeat the process.

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 last summer. (The team set out for its third trip to this land of opportunity last week.) 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 the "mini-Johnson & Johnson (NYSE:JNJ)" -- American Oriental Bioengineering -- 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's 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.

Already subscribe to Global Gains? Log in here.

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