Investing In China

In many ways China is the best of all worlds for the investor.

China is not a free market (sorry, no conservative vision free market capitalism here). Companies in key industries are selected to succeed by the government. Capital investment is carefully regulated. Competition is carefully managed. The currency valuation is artificially controlled.

After a while some additional companies are permitted to operate but they are always at a disadvantage to the “chosen” companies. If the government wants a company to succeed it will succeed. Foreign competition is severely restricted. For example, in the financial sector foreign competitors are just now being allowed to enter the market on a limited basis. If you are the chosen company in a sector then you have a huge head start in terms of market share, brand development and pricing power. This is great for the investor, not great for the consumer.

Right now I continue to be invested in China Life Insurance and China Mobile. They are the chosen companies in their respective industries. For a long time China Life was the only life insurance company allowed by the government to operate in the country and they were able to build a massive, dedicated direct sales network.

I have decided to invest in the growth of Chinese consumerism rather than China’s export economy. A bubble is forming in the Chinese markets, but that bubble could continue to inflate for some time.

Even with the strong run up in these stocks the financial ratios are not out of whack for these two stocks. Actually when the correction occurred in August both of these stocks came down quite a bit. China Life is worrisome in that a substantial part of its earnings are derived from investment gains in an overheated market. However, China Life is the dominant provider of a product that is very attractive to the emerging middle class.

China Mobile has such a dominate position in an underserved market it is hard to see it not going much higher in the long term. They have been very successful in adding value added services such as text messaging and music downloads to their customer's talk time. With 3G on the horizon this story will only get better in terms of revenue per user.

None of this means that financial valuations and other traditional measures of evaluation should not be employed when considering these stocks. There is rampant speculation in Shanghai 'A' shares and this cannot be overlooked. But there are certainly advantages to investing in a somewhat rigged market.

Disclosure: at the time of this posting the author was long CHL and LFC.