Two Ways to Ride the Dragon

06/08/2009 10:54 am EST

Focus: STOCKS

James Oberweis

President, Oberweis Asset Management, Inc.

James Oberweis, editor of the Oberweis Report, finds two smaller growth stocks that have been soaring with the Chinese stock market.

The Chinese Dragon strikes again. So far in 2009, the MSCI China Index is up 30%. China was quick to the punch with massive stimulus and plentiful loans, which in turn increased demand for construction materials, autos, and consumer goods.

Risks remain that rising domestic demand and infrastructure expenditures could fall short of closing the gap from falling exports. Stocks are not as absurdly cheap as they were three months ago, although even after the recent rally they do not appear to be particularly expensive, either. China will be a great place to invest over the medium to long term, even if unpredictable in the short term.

Here are [two] of the most interesting Chinese ADRs.

E-House (China) Holdings (NYSE: EJ) is the largest Chinese property agent, the Chinese version of Century 21.

In 2007, the government tried to curb the rapid rise in real estate prices by raising interest rates and increasing down payment requirements. Buyers paused, but the recent reversal of those policies has bolstered the housing market.

We see E-House as the best way to play a continued rebound in Chinese property sales volumes. The firm has a strong market position, doesn’t carry inventory like developers, and has a healthy balance sheet with no debt. Shares trade for 18x our forward earnings estimate of 75 cents per ADR.

EJ should benefit from both continued increases in market share as well as a positive turnaround in China’s real estate market as it benefits from lower interest rates and government incentives, combined with increased urbanization throughout China.

EJ’s board [also] recently authorized a second $20-million stock repurchase plan. Based on management guidance and improving fundamentals, we expect revenue and earnings growth to significantly improve in the coming quarters, resulting in over 30% growth for fiscal 2009 compared to fiscal 2008. (The stock closed below $17 Friday—Editor.)

New Oriental Education (NYSE: EDU) provides foreign-language training and college test preparation courses. Education is highly prized in China, and the huge gap in wages between the educated and uneducated is leading families to invest heavily in their child’s studies. As the dominant player in providing early English education for children, New Oriental is a household name in China. The company has demonstrated success in helping students prepare for the Gao Kao college entrance exam, similar to the ACT or SAT here in the States. [At Friday’s close around $58, the ADRs] trade for [more than] 25x our forward EPS estimate of $2.20 per ADR.

As we have seen over the past few years, investing in China will yield a bumpy ride. For those who can handle the volatility, however, we believe the long-term reward will be worth the short-term volatility.

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