The plunge in Chinese stocks on Monday, and again overnight, has sent investors and analysts going back into filings to learn more about a company's exposure to the country. The fear is that the horrible stock market is predicting an economic rout by the end of the year. In turn, stocks traded on Monday as if multinational companies would badly miss their recently provided financial projections, which would have trickle effects to the companies that supply them with goods and services.
The daunting images of China's stock market are still close to mind. Despite government efforts to support stocks (as is the case now), about two-thirds of the market's value was destroyed between October 2007 and October 2008. And as you can see in the below chart, things weren't exactly peachy for U.S. indices during that time span.
Granted, that was amid the explosion of a massive debt bubble, but having covered the situation back in the day, China's stock rout (and slowing economy) certainly was ruining investor confidence here at home -- and the planning of major U.S. companies.
Source: Yahoo Finance
The same thought patterns by investors on companies and China are already surfacing: "if the company lists China in its annual report, sell the stock." Ladies and gentlemen, that isn't exactly the correct approach.
Take motorcycle maker Harley-Davidson (HOG) - Get Report, for example. I met with the company's new CEO last night (company veteran -- very impressive leader, very in-depth knowledge of the brand today and its storied history) and the topic of China came up. Well, the reality is that Harley doesn't sell a ton of bikes in China -- it's just not a major market for the company yet. India and Vietnam are two key markets for Harley, which, if anything, have scant correlation to what's happening in China's stock market and economy. However, Harley's stock multiple will compress during bouts of China fears simply because it does business in the country.
Seeing the market toss a name like this out on the news flow is a prime example of what you should be looking to buy amid heavy volatility -- high-quality names that are getting lumped in with the headlines on China. I suggest spending some time today learning your company's exposure to China and other countries, for that matter. Know the percentage of sales for the top-five markets where the company does business -- they usually don't change much quarter to quarter, so what you find will basically be the same for years if there are no major acquisitions or big-time product releases.
If by chance you own stock in names such as Nike (NKE) - Get Report or Caterpillar (CAT) - Get Report -- two companies with direct China exposure -- then you should run down a checklist of things to look for if growth stands to slow in coming quarters (and to determine whether you should dump the stock).
Here is a basic checklist:
Earnings call: Comb earnings call transcripts (they are piling up as we speak!) and keyword "China." This may be rudimentary advice, but I can tell you from experience that investors should kick themselves in the face for not "keywording" transcripts to learn important information. It's embarrassing if you don't. Nevertheless, you are looking for executives flat out saying growth in China has slowed in the second quarter. For those companies that are doing well in China, say Starbucks (SBUX) - Get Report, you are trying to determine the drivers of their performance and whether they could evaporate due to the market's plunge and slowing economy. You don't want to be surprised in the third or fourth quarters.
Sales in China: Compare the sales growth rates on a sequential basis. I will be doing this when handbag makerCoach (COH) reports soon because it has a pretty sizable China business. Over the past two quarters, Coach's sales in China have slowed by a couple percentage points plus the CEO has been making some cautious comments on China's outlook. You definitely don't want to see things like that as a company is investing in infrastructure in China.
Inventory: This may be tougher to detect because execs often don't share the components of company inventory, only offering up the consolidated amount on the balance sheet. But, if your company has over 10% of its business (annual sales) in China, and inventory growth has oddly spiked sequentially, I would be concerned some of the build is from China. The build would reflect unexpected slowdowns in incoming order rates, which could lead to profit-busting markdowns in coming quarters. And, it could lead to manufacturing inefficiencies that weigh on the bottom line.
Editor's Note: This article was originally published at 10 a.m. EDT on Real Money on July 28.
This article is commentary by an independent contributor. At the time of publication, the author held TK positions in the stocks mentioned.