Best Ways to Gain From Booming Chinese Stock Market

New York, NY, August 18, 2015 (Newswire.com) - The original article was published on gathoninvest.blog.com.

China, as the second largest economy in the world, is still growing about seven percent annually, dwarfing the annual growth rate of most developed countries. Naturally, it attracts billions of investors from all over the world. As China’s main stock index soared almost 150 percent from August 2014 to June 2015, more investors than ever around the world crave to invest in Chinese stocks. However, few American investors have actually bought any Chinese stocks. Most are still hesitant because of two main reasons. First, as many Chinese companies listed in the United States were accused of fraud several years ago and saw their stocks collapse and delist (including those whose frauds or financial misstatements were never proven), many American investors are now fearful of being “fooled” by Chinese stocks and do not trust Chinese companies’ financial statements. Second, as many stocks in China have soared several times since last fall, many now command P/E ratios of more than 100 and are considered fully within a bubble at present. So, are there no trustworthy Chinese companies’ stocks priced at reasonable valuation multiples for American investors to invest? Of course there are!

Look at investment legend James Rogers, the most famous high-profile investor and die-hard fan of China. He has successfully invested in countless Chinese stocks for almost 20 years, and he has reaped heavy rewards from these investments. Rogers has been bullish about China for many years and is more interested in investing in China now more than ever, as evidenced by his visit to Guangxi province—the southwestern part of China—this June to observe local economic activities, including real estate and stock markets. He is still buying Chinese stocks and other assets right now. Where can American investors find good Chinese stocks to buy? There are three categories of stocks to look into:

1.    Cheap stocks of small- to mid-sized Chinese companies traded in the United States. The hottest topic of Chinese companies this year is probably Baofeng Technology (Shenzhen Stock Exchange Symbol 300431), a company that offers online audio and video entertainment services. The company originally planned to go public in the United States and worked on doing so in late 2014 and early 2015. However, Baofeng Technology decided to give up on U.S. stock exchanges and instead went public on the Shenzhen Stock Exchange. After an IPO in China, the company’s stock soared an astonishing 42 folds in 56 days, an impossible feat should the company have launched IPO in the United States as originally planned. Another popular Chinese company, KuLong, has also postponed its IPO in the United States because of dissatisfied valuation. Inspired by Baofeng’s great success, many U.S.-listed Chinese companies that have long grumbled about their low valuations are flocking to go private in the United States and to re-IPO in China. For example, the Chinese social media firm Renren (NASDAQ: RENN) received a going-private proposal that offers a 22 percent premium to the company’s average closing price of its stock over the last 30 trading days, prior to the announcement of the proposal. Because most U.S.-listed Chinese companies currently trade at low P/E multiples, compared to their domestic peers and even their U.S. peers (American companies doing similar businesses), those companies can easily offer 20 percent or higher premiums to their U.S. public shareholders to take the company private (and later launch IPO in China at much higher P/E multiples). Since these companies are already trading at cut-rate valuation levels, investing in their stocks now is also relatively safe because the room to the downside is limited. Therefore, U.S.-listed Chinese companies are at a rarely seen sweet spot right now, offering both huge upside potentials and limited downside risk.

In my opinion, among all U.S.-listed Chinese companies that have not received going-private proposals yet, Kingold Jewelry (NASDAQ: KGJI) is the most likely to receive one in the near future. Kingold Jewelry is one of the leading professional designers and manufacturers of gold jewelry in China. It manufactures 24-karat gold jewelry, ornaments, and investment-oriented products. The company sells both directly to retailers and through major distributors across China. It has received numerous industry awards and has been a member of the Shanghai Gold Exchange since 2003. Is the future of Kingold’s business perceived badly? No! The gold and jewelry markets in China are still growing at a fast speed. That is why most gold and jewelry makers, wholesalers, and retailers in China are enjoying high demand and high P/E ratios for their stocks.

As of August 6, 2015, data from Yahoo Finance shows Kingold Jewelry’s stock is trading at an underground level P/E of only 1.22. It is hard to imagine that this company would not trade for at least 30 times its EPS if it were listed in China. For example, mid-size gold seller Hunan Gold is trading for 90 times the EPS! Therefore, most Kingold shareholders can offer public investors a 100 percent premium over the current price to take the company private and then re-IPO in Shanghai for 10 times the price they pay to American investors. This is quite close to a no-brainer arbitration.

2.    Cheap stocks of great companies traded in China. Because China has dramatically opened its domestic market to foreign investors, American investors can directly invest in Chinese stocks traded on the Shanghai Stock Exchange (and soon stocks traded on the Shenzhen Stock Exchange) by two methods.

Shanghai-Hong Kong Stock Connect—Starting November 2014, all people with a brokerage account in Hong Kong can buy stocks traded on the Shanghai Stock Exchange. As a free capital market, Hong Kong allows a person from almost any country to open a bank and brokerage account in Hong Kong. Hence, an American investor can buy stocks listed on the Shanghai Stock Exchange through his or her brokerage account in Hong Kong.

QFII (Qualified Foreign Institutional Investors)—Financial institutions, funds, and investment companies can apply for QFII status and open a brokerage account in China to buy or sell all stocks traded in China, including stocks traded on the new and more risky “Venture Exchange.”

Most American investors do not know these two channels of investing in Chinese stocks yet (especially the Shanghai-Hong Kong Stock Connect). Therefore, people who move quickly now to use these channels will enjoy big first-mover advantages.

Are there safe stocks traded in China? Absolutely! Few foreigners know this, but the punishment in China for “stealing public company’s money” and fraud is actually much steeper than that in the United States. Criminals can easily face the death penalty. Under the new leadership of President Xi, central governments and local governments have been serious about cracking down on all kinds of briberies and frauds for the past year, and they show no sign of slowing down. The safety of shareholders’ money in so-called state-own enterprises is especially high, because these enterprises and their executives are under direct control and close monitor or scrutiny of government agencies.

The question is: “Are there state-owned enterprises that are trad[ing] at cheap valuation multiples in relati[on] to their growth rate”? Intuition may tell you no, because Chinese stock indexes have gained so much during the past year or so (over 1.5 times as mentioned in the beginning of this article). However, some great state-owned enterprises in China are experiencing a fast growth rate, but they have traded at a low P/E ratio. The reason these situations exist is that most investors, especially individual investors, do not know even the basics of stock valuation and mostly just buy or sell stocks based on hypes and technicals (eyeballing the trends and momentums). Consequently, over the short term, even a bad company’s stock can go up multifold if a “big stock cooker” decides to publicize it, while a great company’s stock can have no buying interest if nobody is promoting it (yet).

One company with top-notch growth rate and bottom-notch P/E ratio is Nanjing High Tech (Shanghai stock exchange symbol 600064). The government of Nanjing, the ex-capital of China, founded this company. Nanjing is still one of the biggest cities and an important hub of capitals and economic activities in China. The company, dubbed the “Berkshire Hathaway of China” by some, is probably the biggest company focusing on mid- to long-term investments. The company has founded or invested in more than 20 promising private companies in the technological, medical, health, financial, manufacturing, and food industries, with valuable patents and products of strong current demands and huge future growth potentials. So far this year, the company has had two venture investments that went IPO in China. As an angel investor, Nanjing High Tech has earned returns of ten times on its investments. All other private companies under its arm are following a similar path and probably will go on to IPO one after another over the next couple of years.

Venture capital is currently a business of “outrageous gains” in China for seasoned big investment companies with strong connections and special privileges, such as Nanjing High Tech. Due to its special background and established reputation or connections, the company can easily identify the best handful of rising private companies among thousands each year and pretty much “command” these companies to let it take a significant level of ownership. Consequently, the company can keep on enjoying abnormally high returns on its venture investments for at least the next several years. Nanjing High Tech also selectively invests publicly traded companies. Right now, it has about seven companies under its portfolio of secondary-market investment. Similarly, Nanjing High Tech is using its special status and power to gain privileged information and researches about its targets, and it is often able to acquire shares at special discounts under private arrangements.

Nanjing High Tech’s actions are similar to what Warren Buffet has been doing for years. What is different is that Nanjing High Tech has much higher returns on investments than Berkshire Hathaway does because China is growing much faster than developed countries (and thus, good Chinese companies are growing much faster than good Western companies are). In addition, the Chinese capital market is immature, offering more and better arbitration opportunities because of asymmetric information and social power among investors.

Nanjing High Tech just reported its biannual report. For the first six months of 2015, the company almost doubled its net profit over the same period last year. Indeed, for the past six quarters or so, the company has enjoyed triple-digit YOY growth rate for its bottom line. Sounds astoundingly like a high-growth tech stock that trades at a P/E of over 100, right? Well, amazingly, Nanjing High Tech is trading at a meager P/E of just 18. According to Sina Finance, the biggest financial and stock investment site in China, Nanjing High Tech has the second-highest YOY net income growth rate among its peers, but the lowest P/E in the industry. Compared to its closest competitors, Zhangjiang High Tech and Suzhou High Tech, both which focus on investing in new technologies and industries, Nanjing High Tech’s P/E is less than one-fifth of Zhangjiang High Tech and less than one-third of Suzhou High Tech. Because the valuation multiples of companies doing similar businesses and having similar growth rates should converge over time, an investment in Nanjing High Tech stock today can potentially give an investor a multifold return in the near future.

As China is still a developing country and less understood by residents of developed countries, for most American investors, investing in Chinese stocks surely bears somewhat a higher risk than investing in American companies’ stocks, albeit most of the risks are just conceived and are not real, in my opinion. However, as the golden addicts say, “Time waits for no man” and “higher rewards come from higher risk.” China is growing fast, but eventually it will mature and slow down. As China opens its capital market and strengthens the transparency and reliability of its public companies, buying interest will flock in fast, and the opportunities to buy great companies’ stocks at drastically discounted prices may soon become scarce. Some investors in China who moved decisively to buy great companies’ stocks and hold them for years have enjoyed gains of several hundredfold on a single stock and accumulated tremendous wealth over the years, as Warren Buffet did in the early years of his U.S. investment career. In China, several of the most successful Chinese investors are dubbed “Stock King” or the “Warren Buffet of China.” It may be time for brave and witted American investors to catch up and ride this last huge wave of appreciation for China’s stock market over the next decade.