Bubble? What Bubble? Not in China

10/04/2007 12:00 am EST

Focus: GLOBAL

Jim Trippon

Editor-in-Chief, China Stock Digest

James Trippon, editor-in-chief of China Stock Digest, says earnings growth of Chinese companies more than justifies their share prices, and he finds a stock he thinks is attractively valued.

Plenty of experts and officials have expressed concern about a bubble in the Shanghai and Shenzhen markets. That may well be true of some extremely highly valued companies, but not all.

High [price/earnings ratios] can be justified when earnings are growing very rapidly, and that happens to be the case through much of China’s industrial sector. China’s industrial firms reported $208 billion in profits for the first eight months of the year, up 37% from the year before. State-owned enterprises, once the chronic money losers of the Chinese economy, reported a 31% jump in profits, according to the National Bureau of Statistics.

Looking specifically at companies listed on China’s two stock exchanges, the China Securities Journal reports that combined net profits for the first half of the year were up more than 70%. With that kind of profit growth, fears of a valuation bubble have to be put into perspective.

With the exception of a few fast growing companies, most of our companies have relatively low P/Es, and many are classed as major state-owned enterprises (SOEs) because the Chinese government insists on retaining majority ownership of these strategically vital industries. State control may be poison in most economies, but China’s technocrats are managing steady profit growth in most sectors.

China Netcom (NYSE: CN) delivered a 6% gain in share prices last month. Headlines focused on the fixed-line operator’s slide in telephone subscribers, down by 270,000 for the month of August. That is to be expected as mobile phones increase in popularity throughout China.

Almost unpublicized was China Netcom’s amazing gain of almost half a million broadband users. The Internet is growing so quickly that China is likely to have more users than the United States in less than a year from now. China Netcom’s broadband service is poised to serve that market.

China Netcom has also been boosted by speculation that it will benefit from a major reorganization of telecom services in China. Some media are reporting that China Netcom will merge with China Unicom (NYSE: CHU) to co-develop WCDMA services. China Unicom is the nation’s second largest wireless telephone service provider.

In a continuing effort to expand broadband demand, CN has teamed up with Shanghai Media Group, a Chinese state-owned broadcaster, to offer television through the Internet to 150,000 subscribers in five cities in remote northern regions. China Netcom now has 18 million broadband users.

In accordance with our preference for value stocks, CN maintains a P/E of [around 11x], and its dividend yield is [2.6%]. (The ADRs closed Wednesday below $55—Editor.)

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