Time to Buy Chinese Stocks

China’s astounding economic growth is slowing. Since 2000, with the 2008–09 recession barely a speed bump, the country’s gross domestic product has zoomed from $1 trillion to $10 trillion. Over the next 14 years, however, GDP will more likely just double or triple. That’s an annual growth rate of 5% to 7% rather than the 10% China achieved as recently as 2010.

Even though no country’s economy can grow at 10% forever, the prospect of a Chinese slowdown has investors worried. Over the past five years, SPDR S&P China ETF (symbol GXC), an exchange-traded fund that tracks Standard & Poor’s China BMI index, returned just 3.5% annualized, compared with 15.7% a year for SPDR S&P 500 ETF (SPY), which tracks the popular U.S. benchmark. In fact, the U.S. fund has beaten the China fund in four of the past five calendar years (including the first 11 months of 2014). The bloom is off the Chinese rose.

Better deals. But that may be a good thing. With so many investors unhappy with China, share prices have leveled off and, in many cases, become attractive. If you don’t have China in your portfolio, now is the time to put it there.

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Certainly, some Chinese stocks are doing well. Alibaba (BABA, $108), the Hangzhou-based online shopping mall that’s frequently compared to Amazon.com (AMZN), went public in September at $68 in the largest initial offering ever. Alibaba shares have since surged by nearly 60% and carry a market value of $268 billion, nearly twice that of Amazon and rapidly approaching that of Google (GOOGL). (Boldfaced stocks are those I recommend; share prices and returns are as of December 5.)

Alibaba is growing like crazy. On November 11—Singles Day in China, a traditional shopping event—the company served as middleman on its two main sites for $9.3 billion worth of sales. That’s a world record, and an increase of 58% over Singles Day sales in 2013. Analysts at the Raymond James brokerage see Alibaba’s revenues tripling in the next three years.

Meanwhile, the stock of Tencent Holdings (TCEHY, $15), a Shenzhen-based online-services firm that provides instant messaging and recently made a deal to beam HBO programs throughout China on its video site, has jumped 44% in the past year. Its market value is now $142 billion, about that of International Business Machines (IBM). And wireless provider China Mobile (CHL, $61), a longtime favorite of mine, has jumped 48% since mid March and now carries a market value of $249 billion, 24% higher than that of Verizon Communications (VZ), the largest U.S. telecom company.

I like these stocks mainly because the companies cater directly to Chinese consumers, rather than relying on international trade at a time when Europe and Japan aren’t growing at all and the U.S. economy has been disappointing forecasters regularly.

And Chinese consumers are perking up. For decades, they have been saving excessively. Now they are spending. I recently attended a briefing at which Selina Zhang, of the Beijing consulting firm Meritco Services, laid out a solid case for consumer-oriented Chinese businesses at the same time she cited evidence that China’s GDP would increase by less than 7% in 2015. Because of strong government support for health and pension programs and growing confidence about the future, Chinese families no longer see a large savings buffer as a necessity. Consumer spending is also getting a boost as China relaxes its one-child policy and eases restrictions on migration from rural areas to cities. Zhang pointed to good prospects for sectors such as health care and fitness centers, and it’s not hard to think of other areas that will benefit, such as travel, education and dining.

In health care, consider Concord Medical Services (CCM, $7), which operates imaging centers throughout China. Fast-growing Concord has a price-earnings ratio, based on projections of 2015 profits, of just 12. TAL Education Group (XRS, $30), which provides after-school tutoring at more than 500 locations as well as online, will benefit as China’s birth rate picks up. Its stock has tripled since June 2013 and now trades at 21 times projected earnings. That’s high but seems reasonable in light of TAL’s rapid growth.

I have previously suggested a couple of Chinese companies that I continue to favor: HomeInns Hotel Group (HMIN, $30), with 2,500 hotels in 315 Chinese cities, and New Oriental Education & Technology Group (EDU, $21), a 22-year-old firm that offers test-preparation and language courses in more than 700 locations throughout China and trades at 15 times estimated earnings.

Top fund pick. All of the stocks I’ve cited so far trade on U.S. exchanges, but some of the best consumer-focused companies don’t. Your broker can probably purchase shares for you, but another good way to buy them is through a mutual fund. One of the best is Matthews China (MCHFX), with a modest annual expense ratio of 1.08% and managers who like to buy and hold stocks (the turnover rate is a mere 6% a year). Among the fund’s top holdings are Café de Coral, a restaurant chain that started in Hong Kong and is rapidly expanding on the mainland with brands such as The Spaghetti House, and China Mengniu Dairy, a purveyor of milk and ice cream. (Neither Café de Coral nor Mengniu Dairy trades in the U.S.)

As its name indicates, Matthews China Small Companies (MCSMX) invests in a slice of China’s market. It, too, holds a lot of intriguing consumer names, such as China Lodging Group (HTHT, $23), with 1,500 hotels around the country; Ginko International, the first contact lens maker in China; and TAL Education. One downside: The fund has a high annual expense ratio of 1.5%.

Another strong choice is Oberweis China Opportunities (OBCHX), which has doubled its shareholders’ money over the past three years, despite a troubling 2.07% expense ratio. Among its holdings is Vipshop (VIPS, $22), an online discount retailer whose shares have soared by a factor of 40 since the company went public in March 2012. On the other side of the ledger is 500.com (WBAI, $22), which provides online lottery services. Its stock has fallen 57% since last March, when 500.com came under attack from short sellers, who made what I consider questionable claims about overcharging and some other technical matters.

I would stay away from the China index funds because of their emphasis on industrial, financial and natural resources businesses. SPDR S&P China ETF, for instance, includes China Mobile and online favorites Tencent and Baidu (BIDU) among its 10 largest holdings, but three banks, three energy companies and an insurer account for the other seven stocks among the top 10.

I know that many investors remain skeptical of China. After all, it is a country that suppresses dissent, sends artists to prison, limits Internet access and uses state-run enterprises, especially banks, to direct where money is invested. Still, small consumer companies have a great deal of freedom, and the ruling Communist Party has an enormous interest in promoting economic growth in order to keep unrest at bay. As the Chinese get richer, they will want more of the good things in life: travel, entertainment, education and, of course, ice cream.

James K. Glassman is a visiting fellow at the American Enterprise Institute. His latest book is Safety Net: The Strategy for De-Risking Your Investments in a Time of Turbulence. He owns none of the stocks mentioned.