My Favourite 7 China Stocks
Stock-Markets / China Stocks May 28, 2008 - 10:01 AM GMT
Tony Sagami writes: When Martin called me for a chat the other day, I had no idea he was going to record it, put it up on the Web, and give all of our readers a chance to hear it.
But I'm glad he did — for two reasons: First, because I'm headed for Shenzhen next week on a special new mission — to visit the company that I think will benefit more from the energy crisis than any company in Asia, and perhaps in the world. And second, because, with the latest correction, these stocks are now dirt cheap.
So in case you missed the online recording, here's the transcript. It's hot. It's extremely timely. If you don't read it from top to bottom, I think you'll be making a mistake.
China Stocks Rebounding!
Here Are My 7 Favorites ...
(Edited Transcript)
Martin Weiss: Despite the tragic earthquake in China, the overall Chinese economy is not being negatively impacted.
Quite the contrary, a major new growth phase is now underway, and we wanted to give you this urgent update to explain exactly what's happening and what we see coming.
The big picture is this: Last year China's economy was three times faster than ours — about 10% in China compared to 3.3% in the U.S.
Now the Chinese economy is growing about 17 times faster — nearly 11% in China versus only 0.6% in the U.S. And anyone who doubts the depth or longevity of this stark contrast need only scan the news that's been coming out from both sides of the Pacific.
Right here in the U.S., despite the Fed's eight consecutive interest rate cuts ...
- Consumer confidence has plunged to a 28-year low ...
- Inflation expectations have soared to the highest level since 1982, and ...
- Housing starts have cratered to the lowest level in 17 years.
Nor is the U.S. economy an easy fix. We have the massive burden of $49 trillion in credit market debt, according to the Federal Reserve Board. We have $50 trillion in contingency debts of the U.S. Federal Government, according to the Government Accountability Office. And we also have $164 trillion in derivatives, according to the Comptroller of the Currency.
Meanwhile, in China, despite a series of natural disasters ...
- Retail sales have just skyrocketed 22%. That's the biggest surge since at least 1999.
- Manufacturing has been soaring by as much as 58%.
- And with each day that passes, Beijing is adding an average of over $3 billion to its $2.3 trillion cash hoard.
In China this is not a new phenomenon. The Chinese economy has been growing by an average of 9.7% per year for 26 long years. At that rate, China's economy doubles every 7.5 years, and it could surpass the U.S. as the world's largest economy in just 15 years.
No wonder China's stock market has surged almost four-fold in five years! And no wonder, after a sharp correction starting last November and ending this March, it's starting to move back up again!
Our Asia specialist, Tony Sagami, returned from China a short while ago. And with China stocks starting to take off again, he's getting ready to rush back. So, I have him on the line with us today to tell you more.
Tony, how are you?
Tony Sagami: I'm great Martin, thank you.
Martin: To us Tony, you're kind of like the Indiana Jones of stock hunting in Asia because you go where most analysts dare not go. Could you give us some sense of that and what it really means for the investor?
Tony: Where I go, I don't see my Western competitors. I know where the Wall Street crowd is going to go. I can find them on the 87th floor in the Silver Cloud Room at the Jingmao Tower in Shanghai. Or they might be on the Ginza in Tokyo spending their Wall Street bonuses or drinking tea in scones at the Peninsula Hotel in Hong Kong. But you know where they don't go? It's where the actual commerce is done.
Meanwhile, I'm on the shipping docks dodging forklifts. I'm walking down dusty alleys past snarling dogs and street thugs enviously eyeing my camera.
Martin: Where was this?
Tony: The outskirts of Shanghai when I went to visit a company called New Oriental Education (EDU), which teaches English and helps prepare students to pass college entrance exams both for colleges in the U.S. and China.
Martin: Why is that so critical?
Tony: Oh, gosh if there's anything that the Chinese want it's to get a piece of the American dream.
Think about our ancestors when they crossed the prairie in covered wagons. They did it because they were seeking a better life. In China, they don't have covered wagons. But they do have the ability to learn English.
That's how they can change their family fortune almost in a matter of months — by taking some basic English classes. It's a tremendous opportunity for them. And I think it's the best stock opportunity for investors I've seen in my lifetime. And I've been doing this for 30 years, Martin.
Martin: When did you recommend this stock?
Tony: About a year ago, and it has already doubled. But I think that's just the tip of the iceberg of this company's potential.
Peter Lynch used to talk about "10-baggers" when he ran Fidelity Magellan. I think my 10-bagger is New Oriental Education. It's up about 100% now, but I think there's the potential for another 900% over the years.
The basic rule, Martin, is this: If you want to make money in the next decade, I think you should buy whatever the Chinese are buying. And that covers a lot of things.
In this case, what they're buying is English lessons. But they're also buying oil and natural gas, coal, iron, copper and food commodities. That's why you've seen such wild food price increases — because of the demand from China and India.
If you follow that basic rule of riding the Chinese demand train, you'll do extremely well. But if you dare compete against it, you'll get crushed.
Martin: So ...
Tony: So you have to make sure that you're not only taking a good look at the Chinese companies to buy, but you're also considering which U.S. companies to avoid. If they're competing against Chinese companies, they'll probably lose. And they will not be good stocks to hold.
Martin: Could you first give us an example of a company that you'd avoid? Then, let's go to a couple of examples of the ones that are benefiting.
Tony: Sure. About a year ago, Lenovo bought IBM's personal computer division. They're cranking out computers that have every bit the quality and at a lower price. That tells me Dell is going to have a lot of problems.
Another example of a tough Chinese competitor is Mindray Medical (MR). They make devices that monitor your blood pressure, heart rate, things like that. Similar devices are made by GE and Siemens. Now Mindray, because of their low cost manufacture base in China, can make the same machines for 70% less money.
Plus, they were the first ones to introduce color screen monitors. So they're taking market share from GE and Siemens at an astounding pace. Meanwhile, Mindray is making money hand over fist.
But here's the big theme: I call it the Three C's — cargo, construction, and chuppies.
Chuppies are Chinese yuppies. Right now, there are about 100 million of them. And because of China's one-child policy, they're called the generation of "Little Emperors."
They are well educated because their parents have poured all their energy into educating them, giving them every advantage they can. They typically live with their parents even after they get good jobs. And they have disposable income that you would not believe.
You know, when I go to China I see more Louis Vuitton bags in Beijing than I do in Boston. I see more people sipping Starbucks coffees in Shanghai than I do in Seattle. They love everything western. And they are spending their money to get those things.
So, if you can identify the best companies that cater to chuppies, you should do really well.
Ditto for construction. The biggest building boom in mankind is going on in China now. It's estimated that 70% of all the construction cranes in the world are on Chinese soil.
Every time I go back I see new buildings that weren't there six months ago. The pace of construction is unbelievable. And probably the biggest winners are three companies:
One is China Communications Construction, CCC. The ticker symbol is 1800.HK, trading on the Hong Kong exchange.
The second is ABB, a Swiss construction company that specializes in nuclear plants and bridges and dams. Both are doing tremendous business in China.
And a third company to watch is E-House (EJ), which is the Century 21 of China.
Martin: Did you recommend it?
Tony: Absolutely.
Martin: How well is it doing?
Tony: We bought it in late January and sold it within 48 hours. We made 10% on it in just 48 hours.
Martin: Is that typical of how you trade this market? Just 48 hours?
Tony: No, we have long-term holds that have very strong earnings growth, like New Oriental Education — I plan on holding that stock for years and years. But there are also short-term opportunities.
Because the Chinese markets are volatile, you can make short-term trades and do really very well. Indeed, for the last decade, nearly every dip has been the source of a great trading opportunity to buy in at bargain basement prices.
Martin: Starting in November of last year and through March of 2008, the Shanghai market was down very sharply. Of course before that, it had been up almost 400%. But still, anyone who got in at the top would have suffered a pretty big drawdown from peak to trough.
Tony: That's the Shanghai market. But never forget there are over 100 Chinese stocks that are listed here on the New York Stock Exchange and the NASDAQ. Did the correction take some of those U.S. ADRs down with it? Yes, a lot of them were down 15 or 20%. But not nearly as much as the Shanghai market.
They're volatile — they have corrections. But volatility can be your friend. And that's why we're having this call today! Because it's time to take advantage of that. Buy the lower prices and get ready for some very, very powerful gains.
Martin: Before we go there, tell me how you handled this big correction.
Tony: We did three things. First of all, we took some profits before the worst happened. And the reason is that we use protective stops on most of our holdings.
I didn't pick the time to sell. The protective stops did it for me. At the same time, we held onto the bulk of the portfolio — long-term holdings I believe in, such as New Oriental Education. We didn't want to get shaken out of those positions just because of the market's volatility.
The third thing we did was to buy when things were ugly and nobody else wanted to.
So, it was kind of a three-pronged approach. And boy, it worked out wonderfully. And I think that's the way you have to look at it going forward, too.
There are going to be great opportunities, but there are also going to be corrections. If you have not just the guts — but also the foresight — to jump in when things are cheap, I think you'll do really, really well.
Martin: What gave you the confidence that it was just a correction — not the beginning of a long-term bear market?
Tony: Because stock prices ultimately follow corporate earnings, and corporate earnings follow economic growth. You show me the economy that is expanding, and I'll show you corporations that are making more money.
Like you said at the outset, China has had five years in a row of double-digit growth. And instead of slowing down in 2007, it actually accelerated. So, we don't see any type of slowdown.
With China's economy booming that fast, then you just have to believe that the companies are going to do very, very well. And as we've seen the corporate earnings roll in, we've found that to be exactly the case.
Martin: So there was no correction in economic growth. There was no correction in corporate earnings. There was no correction in sales growth.
Tony: Absolutely! It was just a rubber band that got stretched thin. And some of the speculative juices had to be rung out. But those are not long-term problems. They are short-term opportunities.
Martin: What are some of the other opportunities you're looking at going forward?
Tony: One of the first things you'll notice in Asia is that it seems like everyone has a cell phone that is surgically sewn onto their ear. And if you have kids, you might have seen the new phenomenon of text messaging. Well, in China, they even have an epidemic in carpel tunnel syndrome because people are texting so furiously.
China Mobile (CHL) is the largest cell phone company in the world, and it trades here on the New York Stock Exchange. They have 390 million subscribers. That's more subscribers than the U.S. has citizens. And they still have only punctured a piece of their market.
More importantly, a cell phone in China serves a very different function than a cell phone in the U.S.
They usually can't afford a personal computer or laptop. So the cell phone is the PC. Once you understand that critical function of the cell phone in Asia, you'll understand why the usage is so high, why the profits are so strong, and why the growth is likely to keep on going.
And they're just getting ready to unleash their 3G, or third generation, network. So profits at China Mobile are going to explode. That's another stock that went up by over 200% profits, and I still don't think it's even scratched the surface of where it's going.
Martin: Tony, you've talked about a lot of your winners in your portfolio. I think it's only fair that you tell us a little bit about your losers, too. Could you give us a couple examples of those and why?
Tony: Sure. Earlier we talked about protective stops. When I've had losers, it's typically because of the stops — not because I picked bad stocks but because they got caught in the correction and the stops took us out. Mindray Medical, which we talked about earlier, is one of them.
Remember? The one that makes monitoring devices 70% cheaper than GE.
Martin: Yes.
Tony: We bought it. We were up nicely. But our protective stop was a little bit below our purchase price. During a correction it went down, and we got stopped out. Since then, the stock has zoomed higher. I wish we still owned it. But we don't.
Also, we owned Cameco, which is the largest uranium producer in the world. China has six nuclear plants currently under construction and plans to build upwards of another 50. Uranium is one of the only viable, non-greenhouse-gas energy sources. And I believe very strongly in its future.
Martin: So you would buy that stock back even though you got stopped out?
Tony: I'm waiting for an opportunity. The problem is you have to commit so much capital if you want to buy 100, 200, 300 shares.
Martin: But sometimes you can use options on those.
Tony: Yes you can. I may not want to commit $20,000 to a position. But I may not hesitate to put a few hundred dollars into it, especially if it has momentum.
Martin: So, in the case of Mindray, or stock like that, you would not have gotten stopped out.
Tony: Right. One of two things could have happened. Either you would have lost your entire small initial investment. Or if you had enough time on your side — if the expiration date was further off in advance — you'd still be holding on to it. In the case of Mindray, that would be like money in the bank because it zoomed higher since we got stopped out.
We ended up losing about 15% on that trade. But, instead of losing 15%, you probably could have made upwards of 500%.
That's how powerful options are if you get a stock that's moving up strongly. And that's exactly what Mindray did.
Martin: Let me ask you this: The U.S. economy, as we said at the outset, is crawling along at a 0.6% growth rate per year. And there is a real risk that it could actually begin to contract, which means American consumers will be buying fewer Chinese goods. How do you see that impacting Chinese stocks?
Tony: That's the superficial view of the knuckleheads on Wall Street who have never set foot in the economic zones of China. The truth is, the U.S. accounts for only about 17% of China's exports. That means 83% is going somewhere else. And the percentage to the U.S. is going down.
Here's a number for you: In 2000, the European Union's imports from China were 35% smaller than the U.S. imports from China. But in 2007, their imports were 15% larger.
Martin: Suppose the European Union has a recession. Then what?
Tony: It's a small world. But China's real opportunity is in two other places where the business is growing like crazy.
First of all, its Asian neighbors in Malaysia, Indonesia, Taiwan, Japan, South Korea, and India. These countries are prospering. So they're buying more. And they're growing at a rate so fast they'll probably replace whatever China loses to the U.S.
But China's most important opportunity is not so much its Asian neighbors, but its own Chinese citizens. Chinese domestic consumption is growing just as fast as, or faster than, the Chinese economy itself. So, they have their own internal consumption. That is more than making up for anything they lose to the U.S. Whether the U.S. goes into recession or not, it is not going to affect China that dramatically.
So what are you talking about? Maybe instead of a 10% growth, it'll go to 9%? That's like trading in a Ferrari for a Porsche. You're still going fast.
Martin: And certainly a lot faster than the U.S.! You're saying that we've had the correction in the Shanghai market, and it's now recovering. So what are you going to do about that?
Tony: Start buying. This is the bargain. The mistake people make is that they think only about the U.S. situation. We have $130 oil, and that's horrible. We have the subprime mess. We've got real-estate values cratering. But those things don't affect China the same way they do us.
The Chinese don't care about $130 oil; they can ride bikes and ride the subway. So, the oil impact over there is not going to be even a fraction of what it is to the U.S.
Real estate? Last year in China 80% of all home purchases were paid 100% cash. So they don't have to worry about the lack of liquidity or subprime lows. You're talking about a country that has a savings rate of 25% and many children living with their mom and dad until they're ready to buy a home. So the forces that are pushing the U.S. economy down are not evident in China.
Martin: They must affect it to some degree. If Europe and the U.S. are both weakening, it's going to have some impact. But what you're saying is it's going to be an impact that reduces their growth rate but doesn't throw them into a decline.
Tony: No. Here are some numbers that really tell the story. Right now, the average Chinese stock is selling for 21 times forward earnings. Sounds a little pricy right? But do you know what the average U.S. stock is selling for? 22 times forward earnings!
Martin: Then what's the big difference there? Why would you say that Chinese stocks are more attractive if their P/E is basically the same?
Tony: Ah, because it's how much growth you're getting — how much bang for your buck. U.S. companies might be lucky to see their profits grow by 4%, 5%, 6%, 7% a year. But with the Chinese companies, the corporate profit growth I'm seeing is 20%, 30%, 40%, 50% a year.
Martin: So please give us the formula for that.
Tony: It's the PEG ratio, price/earnings to growth. It's just a way to quantify how much growth you're getting with your profits. For example, if you're paying 20 times earnings for a stock that's only growing at 10% a year, that has a PEG of 2.0. That's not good. Anything over 1.0 means you're paying dearly for the growth.
On the other hand, if you have a stock that's trading for 20 times earnings but growing at 40%, that's 0.5, which is very good. That's the type of PEG ratio we have with most of my favorite stocks in China.
When we were kids, we used to play a game called "Crack the Whip." Kids would hold hands in a long line. And then they'd start running. Because of the leverage, the people at the end of the line would really get whipped around. It's the same thing with Chinese stocks.
If you want to whip up some big, big profits, you want to go at the end of the line where the growth is the most fantastic. And that's in Asia, specifically in China.
Martin: Tony, very soon you're going to hop on a plane and head over to China. If we could tag along with you, what would we see?
Tony: I'm going to head over to Hong Kong and cross the border to Shenzhen, one of the major manufacturing areas of China.
The first place I'm going to go is a company that makes batteries, portable batteries. They make batteries for MP3 players, iPods, cell phones, laptop computers. If it's portable and it needs a battery, they make it. That by itself is a very profitable business.
Meanwhile, with the oil price as high as it is, one of the most popular items in the world is going to be the hybrid vehicle. So this company is taking their battery technology, one of the best in the world, and applying it to automotive batteries.
I believe they are about to land a very lucrative contract with a major U.S. auto manufacturer. If they get that, and I think they will, this stock is really going to explode. It's only around 5 bucks a share right now. I can see it jumping to $7, $8, $9 dollars a share almost overnight.
Instead of investing in an oil company or solar power, I think this is a great stealth energy play and the best way to take advantage of rising energy prices.
Martin: Batteries do provide energy.
Tony: And they don't emit greenhouse gasses either.
Martin: OK. That's the battery company. After you visit them, what will be your next stop on the trip?
Tony: I'll take a ferryboat across the border to Macau. Macau was a Portuguese colony for hundreds of years but recently went back to Chinese rule, becoming a special economic zone. It is the only place in China that has legalized gambling. So it has become the Las Vegas of Asia. And one thing about Asians — they like to gamble.
Martin: You yourself were born in Japan.
Tony: Yes, I was. I'm a U.S. citizen. I came to the states when I was one year old. But my mother always told me: "It doesn't matter where your feet are. You're always Japanese."
I'm going to go over to Macau because they've just opened two new casinos. And I want to see with my own eyes how busy they are.
These are multi-billion dollar casinos. If they made a mistake, it will be a huge flop, and the stock will tank. But if they're filled as they have been in the past, the stock will skyrocket. And I want to see it with my own eyes, talk to the dealers, the pit bosses, the taxi drivers.
You'd be amazed at what you get from those people. I ask them "How's the business? What's going on?" But more important, I want to find out which casino is the very best one.
There are four different casino companies you can buy in Macau. But one of the stealth plays might be the company that has an exclusive monopoly on the ferry service that goes back and forth from Hong Kong to Macau. Maybe that's a better play than the casinos themselves. I'm not sure.
I'm going to get my boots on the ground to figure out the very, very best way to play that Asian gambling boom. We're about in the third inning of a very profitable nine-inning game. And I think the opportunities are just fantastic.
The World Bank estimates that China's going to grow by 8% a year until 2025. If anything, I think that might be too conservative.
If you want to make money in the next decade, you have to add some Asian spice to your portfolio. And the opportunities that I run into over there could be some of the most productive investments you'll see in our lifetime.
Martin: And you are how old?
Tony: 51. And I don't think we'll see a bigger booming market than what's happening in China for the next 20 to 30 years.
Martin: But, you're taking good care of yourself.
Tony: I am. I run four miles a day, eat right, and live right.
Martin: And you've lost some weight. How many pounds?
Tony: Oh gosh, 40. I've gone from 230 to 190. But at 190, I still wouldn't call myself skinny. I've got a little ways to catch up with you, Martin.
Martin: On that note, I'd like to thank you very much, Tony. I'm looking forward to talking to you again when you're in China. So, could you give us a call when you arrive and you've recovered from your jetlag?
Tony: I will call after I visit the company. Because in the past, I have rushed out of meetings with officials in factory tours, got on the phone, called the office and told them to insert it into a flash alert right away. And when I find them, those have historically been our most productive picks of all.
Almost every one of our triple-digit winners has been that kind of situation. When you see it, you have to act because that's how hot it is. It's actually being there on the ground.
Martin: If you're here in the states, you're looking at the same research reports and the same balance sheets and financial statements that all the other guys in Manhattan are looking at. You're not going to find any golden nuggets of information in there. That's just basic balance sheet analysis.
Tony: That's how you avoid making mistakes. But the way to find the opportunity is to kick the tires yourself. That's the difference; and that's why we've been successful.
Martin: Thank you very much Tony for joining us. I'm looking forward to talking to you after you visit the first company in Shenzhen.
Tony: I will call you right away.
[Editor's note: For more information on Tony Sagami and his service, call toll-free 1-800-285-7264.
By Tony Sagami
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