Rock-Bottom Buys from China

07/11/2013 7:00 am EST

Focus: GLOBAL

James Oberweis

President, Oberweis Asset Management, Inc.

Yes, China's economy is slowing, but select Chinese stocks are cheap, cheap, cheap, says Jim Oberweis, editor of The Oberweis Report.

Jumping on the latest investment fad is just as American as baseball, We used to think it was a plague of the retail investor, but we've since come to believe that the so-called "smart money" institutional investors are equally afflicted.

Indeed, in some corner office in New York right now, you'll probably find a pinstriper working diligently to name the next new trendy strategy. They come up with names like Market-Neutral, 130/30, Global Tactical Asset Allocation, and Risk Parity.

The paradox is that such investment strategies often play on sentiment of the past (more out of marketing than brains) rather than anticipating sentiment in the future.

Investors—both retail and institutional—have the disastrous tendency to jump on the bandwagon into fashionable strategies, rather than focusing on undervalued opportunities. We think the intelligent investor seeks opportunities that are out-of-favor and trade at out-of-favor valuations.

The big pig in the room these days is China. It has been eight years since we started the Oberweis China Opportunities Fund (OBCHX). Since then, we've seen sentiment toward China investment come full circle.

China was viewed as a backward third-world country when we started, then morphed into a "can do no wrong" growth powerhouse in the late 2000's. Then it collapsed back to today's view that everything is a fraud in that "house of cards."

We acknowledge that growth in China is slowing. Tighter liquidity (driven by Beijing's marching orders) is putting pressure on banks and export firms. Non-performing loans are on the rise, or will be shortly. Prosperity for the average man, for the first time in a couple of decades, may decline.

Given the high concentration of wealth in China and public disgust with corruption by the elite, there is admittedly above-average risk of social unrest. Still, that's only half the story, and not the most important half. The US has problems too, and China's structural issues have been familiar for a long time.

Much of the "dreaded slowness" stems from changes in government policy. New leadership in China appears to have the cojones to tighten credit to put China on a slower but more sustainable growth path.

Long term, it's the sound decision. And we think the government stands as a backstop. They have the balance sheet and policy tools to ease the pain by reversing course a bit if the proverbial soft landing potentially turns hard.

But here's the real thesis: Chinese stocks are cheap, cheap, cheap. The MSCI China Index is trading at a rock-bottom P/E ratio of about seven times earnings, with a price-to-book ratio of less than 1. Our more growth-oriented China Opportunities Fund presently has a P/E 20% below its historical average.

And not everything is slowing. Select parts of the Chinese economy are still booming, like e-commerce, IT infrastructure, health care, and environmental protection.

An example is our latest featured stock, Vipshop (VIPS), which offers high-quality branded products to consumers in China through "flash sales"—a new online retail format combining the advantages of e-commerce and discount sales.

In the company's latest reported first quarter, sales increased approximately 207%, to $310.7 million, from $101.3 million in the first quarter of last year. Vipshop reported earnings per share of 17 cents in the latest reported first quarter, versus a loss in the same quarter of last year.

Clients of Oberweis Asset Management own approximately 79,000 shares, which we believe may be appropriate for risk-oriented investors.

Other stocks like Vianet (VNET), Netease (NTES), Spreadtrum (SPRD), and eCommerce DangDang (DANG) are set for continued growth even as the broader economy slows.

Overall, China isn't popular, but it will prove profitable. Cheap valuations will trump its structural issues.

The wealthy in China love their fashion from Paris and New York and London, and yet their equity markets are currently the rags of the world again. We believe that over the long term, Chinese equities will "clean up" well.

As the pendulum of investment fashion swings, don't follow the crowd. When valuations for any sector or geography approach record low P/Es, consider bucking the trend.

Subscribe to The Oberweis Report here...

More from MoneyShow.com:

China ETFs Feel the Pressure

The Far East Is Proving Yum!my

Best Global Investing Bets

Related Articles on GLOBAL