China Growth Stocks

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Ryan, we're getting the perfect storm here of factors that work well for our space: Shanghai Composite moving up vigorously, China's economy humming along nicely, U.S. markets running on bullishness with many money managers having missed the recent upturn and wanting to get some upside gains in their clients' portfolios (same dynamic helped the 2009 rally become a monster), and the Fed juicing the markets and the "Bernanke put" creating a strong floor of protection for the mkts...

And suddenly investing in China is really popular again, the Harbin news making a lot of investors realize how undervalued our space is, and the risk trade is back on, so the smallcaps and even microcaps may finally again have their day in the sun.

Last but not least? Buffett is making very bullish statements again about China... Saw the following article earlier today at Forbes online....
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10/13/10:
http://blogs.forbes.com/investor/2010/10/13/china-picks-buffett-might-like/?partner=yahootix

Intelligent Investing: Ideas from Forbes Investment Team
China Picks Buffett Might Like

Posted by JOHN REESE

[Caption for deleted photo: Warren and Bill do China]

During his recently trip to China, Warren Buffett quashed rumors that he’d soured on his big investment in Chinese electric car-maker BYD — and he indicated that he’s on the prowl for more investments in the rapidly growing Asian power.

“China’s a very big economy and it’s going to get a lot bigger,” Buffett said, adding that China’s transformation is “unlike anything that’s ever taken place in history.” according to Bloomberg News. “That means it has large investment opportunities and that’s what Berkshire Hathaway is looking for,” Buffett said. “We need to put large sums to work, so China is a logical place.”

Buffett’s comments got me wondering which Chinese stocks my Buffett-inspired Guru Strategy is high on right now. After screening dozens of U.S.-traded China stocks against the model, one that stood out was cell phone giant China Mobile Ltd. (CHL), which I featured in my most recent Forbes.com article. (Click here for that article.) But I also found a couple other smaller China plays that get solid marks from my Buffett-based strategy.

Here’s a look at why my Buffett model is high on these two firms. (Keep in mind, I’m not predicting Berkshire will scoop up these companies or their shares; in fact, they may be too small for Buffett’s giant firm to bother with. But they do possess the fundamental qualities Buffett looked for in investments when building his empire, which means they’re worth a look.) I’ve also included a couple top China picks from some of my other Guru Strategies. Be aware that these types of smaller China plays are likely more volatile and riskier than other larger stocks.

RINO International Corporation (RINO): Based in Dalian near the Yellow Sea, a few hundred miles from Beijing, this small-cap ($440 million) makes wastewater treatment, desulphurization, and other environmental protection and energy-saving equipment used by iron and steel companies. It’s a field with strong growth potential, given the impressive expansion of China’s manufacturing sector — and the rise in government environmental regulations designed to deal with the impacts of that growth.

My Buffett-based approach looks for companies with lengthy histories of persistent earnings growth, and RINO fits the bill. Its earnings per share haven’t declined in any year of the past decade, and its growth has been exceptional more recently — EPS over the past five years, from earliest to most recent, have been $0.02, $0.18, $0.52, $0.85, and $2.22. The company also has enough annual earnings ($78.3 million) that it could pay off its debt ($8.1 million) in a matter of months if need be, which the conservative Buffet approach loves.

Buffett is also known to prize strong management, and one way he has measured management’s success is by looking at how it uses retained earnings (i.e., those it doesn’t pay out in dividends).

Over the past 10 years, RINO management has earned a 58.6% return on the earnings it has retained, which wallops the 12% target this model uses, a great sign. (This figure is determined by dividing the amount EPS have grown in the past ten years — $2.22 — by the total amount of earnings retained — $3.79 — over that period.)

My Buffett model does find some flaws with RINO involving its returns on equity and total capital. While RINO has posted strong results in both categories over the past five years, the stringent Buffett-based model digs back a full decade into a company’s history. And, in the first half of the last decade, RINO’s ROEs and ROTCs were actually in negative territory. So, while its vast improvement over the past five years is very encouraging, it fails these two tests.

TECHNE Corporation (TECH): While based in Minnesota, this biotech firm established a subsidiary in Shanghai a few years back, so it has a significant way to tap into Chinese growth. TECHNE makes products used in hospitals and clinical laboratories to check the accuracy of blood analysis instruments. It also makes biotechnology products such as purified proteins and antibodies.
TECHNE ($2.3 billion market cap) gets high marks from my Buffett-based model, in large part because it has upped EPS in all but one year of the past decade (and that was nine years ago). In addition, it has no long-term debt, and has averaged a 19.7% return on equity over the past decade.
TECHNE’s management also appears to be doing a solid job — the firm has generated a return on retained earnings of 13.4% over the past decade.

China Yuchai International Limited (CYD): Incorporated in Bermuda with operational headquarters in Singapore, China Yuchai does most of its business in China. Its main business is Guangxi Yuchai Machinery Company, which is one of the largest medium-duty diesel engine manufacturers in China. The firm also has subsidiaries involved in consumer electronics, property development, and hospitality.
China Yuchai ($790 million market cap) gets a very high score from the model I base on the writings of hedge fund guru Joel Greenblatt. In his Little Book that Beats the Market, Greenblatt laid out a remarkably simple two-variable “magic formula” that has beaten the market by a wide margin over the long haul. The two variables: earnings yield and return on capital. China Yuchai currently has a 27.8% earnings yield, which ranks 8th out of the thousands of stocks in my database; its return on total capital is even better, at a whopping 1,489%, which ranks 2nd. Those figures not only help China Yuchai pass my Greenblatt-based model — they make it the #1 overall stock in the market, according to the strategy.

China Integrated Energy, Inc. (CBEH): A non-state-owned company, China Integrated has three main businesses: the wholesale distribution of finished oil and heavy oil products, the production and sale of biodiesel, and the operation of retail gas stations. It’s located in Xi’an City in Central China.
China Integrated, which has taken in about $380 million in sales in the past year, is a small-cap ($280 million), so it has the potential to be more volatile than larger stocks. But the model I base on the early writings of Forbes’ Kenneth Fisher thinks it’s worth a look. While most investors had focused throughout history on the P/E ratio as a way to find bargains, Fisher noted in his 1984 classic Super Stocks that earnings — even the earnings of good companies — can fluctuate greatly from year to year due to factors like one-time facilities upgrades, property sales, or legal fees. Sales, however, are far more stable and indicative of a firm’s performance, Fisher found, leading him to develop the price/sales ratio (PSR). For non-cyclical firms, my Fisher-inspired model considers PSRs below 0.75 to be tremendous values; at 0.74, China Integrated makes the grade.
Other reasons this model likes China Integrated: The company has a debt/equity ratio of just 2.4%; its inflation-adjusted EPS growth rate is nearly 60% over the long-term; and its three-year average net profit margins are a very healthy 10.5%.

I’m long CYD and CHL.
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