How To Find Winning Chinese Stocks

| October 1, 2009 | 0 Comments

The Chinese stock market’s on fire this year.  Year to date the Shanghai Composite is up a hefty 51%.  That compares with an 11% rise for the Dow, a 17% increase for the S&P 500, and a 34% gain for the NASDAQ.

Investors are buying up Chinese stocks hand over fist for three main reasons.

The Chinese economy is growing faster than any other this year (better than 8%).  The Chinese government’s $587 billion in stimulus spending is giving a boost to corporate growth rates.  And, low interest rates are enabling Chinese companies to cheaply borrow money to fund their future growth.

All of these policies are combining to fuel a high growth environment in China.

I’ve been a big fan of Chinese stocks all year.

Subscribers to my investment advisory services can vouch for that.  They’ve made a lot of money this year in Chinese companies.  I don’t mean to brag… but, we’ve seen gains of 105%, 155%, 233% and 271% in just the past seven months.  (And, I think they’re heading even higher.)

Our success has prompted lots of questions.

People are always asking how I consistently find these great Chinese stocks.  I usually smile and tell them its “classified” information.  But, today I’m going to share a bit of my process with you.

As an added bonus, you’re going to learn about a Chinese stock with huge upside potential.

The two main things I look for are a high growth rate and a reasonable price.  This year I’ve been finding a lot of Chinese companies with these characteristics.

Right now the average long-term earnings growth rate for stocks is about 16%.  But, I want something better than average.  That’s why I look for companies with projected annual growth rates of 20% or more.

However, a high earnings growth rate by itself doesn’t mean it is a good investment.  You have to look at the price relative to that growth rate.

That’s where the PEG ratio comes into play.

The PEG ratio is a simple way to tell if a company is overvalued or undervalued.  You simply divide the P/E ratio by its long-term projected growth rate.  For example, let’s say you’re looking at a company with a P/E of 10 and a projected growth rate of 25%.  Divide 10 by 25 and you get 0.4.

What does this number mean?

A PEG ratio of 1.0 means the stock is fairly valued relative to its growth rate.  A score higher than 1.0 means it is overvalued.  And, a score below 1.0 means it’s undervalued.

In our example, a PEG ratio of 0.4 indicates the shares are significantly undervalued.

Buying stocks with high earnings growth rates and low PEG ratios can lead to huge profits.  If the company is otherwise fundamentally sound, you can bet the market will eventually drive the price up.

What’s more, in a strong economy or hot market, you’ll often see shares trading at significant premiums to their growth rates.  PEG ratios of 1.5, 2.0, and higher are not uncommon in frothy markets.

A word of warning…

Those with high growth rates and low PEG ratios by themselves aren’t necessarily good investments.  As always, do your due diligence before buying.

Now, as promised, here’s a high growth Chinese stock trading at a very reasonable price.

Introducing, China-Biotics (CHBT).

CHBT is one of the largest suppliers of probiotics in China. Probiotics are beneficial, live bacteria used as dietary supplements and food additives.  They help improve intestinal health and digestion.

Demand for probiotics in China is rising rapidly.  A Beijing research firm predicts the market will more than triple next year.

And, CHBT is benefiting nicely from this trend.

Last quarter, revenue jumped 35% year over year to $15.4 million. Gross margins were high at over 70%.  Net income soared a whopping 78% to $5.8 million.  And, earnings per share of $0.31 handily beat estimates by 14 cents.

The outlook for the rest of fiscal year 2010 is very good.

Management sees revenue surging by at least 50%.  And, earnings are expected to jump 30% to $1.30 a share.

Despite this high-powered growth, CHBT is trading at a deep discount to its growth rate.

The projected long-term growth rate is 30% annually.  At a recent price of $16, the stock’s P/E ratio is 12 times the current year estimate.  This yields a PEG ratio of just 0.4.

In other words, the stock’s trading at a 60% discount to its long-term growth rate.  You can see this has a ton of upside potential.

CHBT is a perfect example of what I look for.  A solid product in a fast growing market.  High revenue and earnings growth.  And, a cheap price.

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Category: Foreign Markets

About the Author ()

Robert Morris is the editor of Penny Stock All-Stars, an investment advisory focused on discovering small-cap and micro-cap stocks that are destined to become the market’s next Blue Chips. The Wall Street veteran and small-cap stock specialist is also a regular contributor to Penny Stock Research. Every week, Robert shares his thoughts with our readers on a variety of penny stock-related topics. In addition to Penny Stock Research, Robert also writes frequently for two other free financial e-letters, ETF Trading Research and the Dynamic Wealth Report. He’s also the editor of two highly successful and popular investment advisories, Biotech SuperTrader and China Stock Insider.

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