How to join in the growth of China?

December 8th, 2006

Share |

As we mentioned yesterday in Why is China printing so much money?, we believe there are better alternatives in taking part in the rise of China than sinking your money into the wild liquidity of the Chinese economy. It is a mistake to simplistically assume that to take part in the rise of China (or India, Brazil, Russia, etc), all you need to do is to pour your money into the sizzling Chinese (Indian, Brazilian, Russian, etc) stock market and watch your wealth grow. In case you do not know, it is very much possible for the stock market of a high-growth country to fall significantly while the rest of the economy is humming along fine?it has happened before in China and it happened in India this year.

We should keep in mind the following general rule of thumb: In the long run, the stock price of a company should grow at the same rate as the growth in the profits of the company. Similarly, in the long run, company profits can only grow at the same rate as the growth in the overall economy. With this rule of thumb, whenever we see stock prices outstrip the growth of the overall economy by a far margin, it is time to beware. This may be a sign of a bubble. As we mentioned in Divergent sentiment , if you are the central bank you can make the stock market index climb as high as you want simply by printing money. This is what is happening in China right now. With all these China growth stories, it is tempting to assume that any managed funds that invest in Chinese stocks will automatically do well in the long run. True, some of these funds may seemingly do well in the short run, but unless you are a fast and nimble short-term trader, investing your money into them for the long term may not be a good idea (note: if you are a short-term trader in the Chinese stock market, you will not be investing in that managed fund in the first place). And before we get criticised, please note that we are NOT saying that ALL managed funds that invests in Chinese stocks are bad?we are merely stressing the importance of not judging the quality of a fund just on the basis that it invests in Chinese stocks.

Now, what is our preferred way of taking part in the growth of China? For us, as contrarians, we prefer to seek out companies that have China as their target market. In other words, we prefer companies that sell their goods and services to the Chinese. As China grows richer and stronger, their purchasing power will increase. For this, we will have to study the needs, trends and fads in China to discover what are the things that the Chinese wants and have the money to buy. A business that is well positioned to take advantage of that will garner our interest.

Tags: ,