10/18/2012 11:45 PM ET|
4 'good' (and 5 'bad') China stocks
So what's a 'good' stock?
"Good" China stocks share a number of characteristics in their business models and in their financial statements.
For example, they often pay dividends.
Why is that important? Not because these companies pay a mouthwatering yield. Most dividends in the Chinese market are quite modest. But it's worth buying dividend-paying stocks in China's markets because it's relatively hard to fake a dividend payout. The check either arrives or it doesn't. A company that pays a dividend is probably generating cash (although in financial history, you can certainly find companies that were borrowing money in order to pay a dividend). So a Chinese stock paying a dividend is more likely to be making a profit and showing positive cash flow. Think of a dividend payout as a proof of concept for the stock.
So I'd put Guangdong Investment (which trades as 270.HK in Hong Kong) in my "good" stocks category because it pays a 2.95% dividend. That cash comes from the company's cash flow as Hong Kong's water utility. If management ever significantly botched its other business -- the company is a major property developer -- so that the utility cash flow wasn't sufficient to cover the dividend, there's a good likelihood that it would manifest itself in a lower dividend that would be apparent to investors. (Note that the company also trades as an ADR in the U.S., GGDVY, which pays 2.28%.)
Café de Coral (331.HK in Hong Kong) gets points for its dividend yield -- 2.82% -- and the double-check that yield provides on the company's operations and financials. The 40-year-old company is the largest fast-food restaurant company in Hong Kong, with 320 restaurants (including Spaghetti House and Super Super Congee and Noodles) in Hong Kong and an additional 278 overseas. Sales for the fiscal year that ended in March climbed 12%, while profit of $HK474 million ($61 million) fell by 8% due to higher costs. The company's final dividend payout of $HK45 a share ($5.81), a 74.6% payout ratio, is a good double-check on those numbers.
For example, the dividend has been rising in the past few years, which is good. But the percentage of earnings paid out via that dividend -- the payout ratio -- has been climbing, too, from 67.7% in fiscal 2010 to 74.6% in fiscal 2012. That's bad, since at 74.6%. an investor is entitled to wonder how long the company can afford to continue that payout. (Note that the company also trades in the U.S. as CFCGF, which pays 2.91%.)
I'd call Café de Coral a good China stock for reasons that go beyond its dividend payout, however. It gets points from me as a good China stock because its business is relatively visible -- if the company wasn't making sales, its restaurants would be empty -- and because it's not a terribly complicated business. An investor can track commodity costs, read about labor costs and check out price trends by looking at its menus online or dropping by one of its restaurants. (Café de Coral operates the Manchu Wok chain in the United States, so you don't even need to fly to Hong Kong.)
The company's business is one that we all are familiar with and understand. That makes it relatively harder to fake results than if Café de Coral ran a wind power company where sales could be subsidized by local governments -- great until the subsidies run out -- or where customers are themselves complicated entities that may or may not be actually consuming what they buy.
(Please, let me be clear: China is not the only country to have known stock market fraud, and management around the world is amazingly inventive at discovering ways to hoodwink investors. One of my favorite stories is that of famed company rescue artist Q.T. Wiles who "turned around" disk drive maker MiniScribe in the 1980s by, among other things, shipping bricks packaged as disk drives. Sales, according to the company's books, climbed to $603 million in 1988 from $115 million in 1985.)
Another "good" China stock on this basis is Home Inns & Hotels Management (HMIN). It's pretty easy to count guests at the company's motels, and claims of 100% occupancy, as the company reported at some motels during the recent peak travel Golden Week holiday, are relatively easy to debunk. And as with Café de Coral, because Home Inns & Hotels runs a mass consumer business, the company can't move the revenue needle by booking one or two or a dozen big sales.
The fact that a Chinese company has done a deal with a well-known and, in theory, savvy Western company doesn't, by itself, turn it into a "good" stock. Sophisticated Western investors have been taken for a ride in China, just as in the 19th century sophisticated English investors were hoodwinked by U.S. robber barons who bought going railroads and then sold a river of shares until investors were left with nothing but worthless, watered-down stock. But I'd still say that a foreign deal or two tells you something about a company and its stock. For example, Home Inns & Hotels Management acquired the Motel 168 chain from Morgan Stanley (MS) in a 2011 deal that was partly financed by JPMorgan Chase (JPM) and Credit Suisse (CS). Investors know that Morgan Stanley, JPMorgan Chase and Credit Suisse all did due diligence on Home Inns & Hotels -- although we can't know how good that due diligence was.
Sometimes a "good" stock characteristic is overwhelmingly strong. In other cases, a stock gives you a list of "good" stock characteristics but each one individually is relatively weak. For example, Ping An Insurance (PNGAY) does pay a dividend -- but it's just 0.79% -- and it does have "sophisticated" Western investors such as HSBC (HBC), even if Western banks have a mixed history in their investments in Chinese financial companies.
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