How (Not) to Invest in China

Before you read any further, note that this article is intended only for people interested in making more money than other people. It is very complicated and very few people in the world actually are capable of doing it right. If you aren't interested in beating the mean, buy everything indiscriminately with the iShares MSCI ACWI Index ( ACWI)(ACWI) exchange-traded fund, which is a benchmark for global stock performance. For the rest of you, read on.

How do you identify if you are making a "dumb decision"? Let me illustrate by showing how you're likely allocating your time poorly. I'd say you spend more time shopping for quickly depreciating assets in your lifetime than you will those that are likely to increase in value. In any given year, you probably spend more time shopping for your weekly groceries ($200), than you do for your car ($20,000), than you do for your home ($200,000), than you do for you investments ($?).

Here are the most commonly fumbled investment steps.

Step 1: Figure out what you (don't) want.

In case you didn't know, the Shanghai market has been kicking the crap out of the U.S. market over the last eight months. So, you want to invest in China? This is a once-in-a-lifetime opportunity for me to tell you that you're doing it wrong. Your goal of investing should be "to make money." Granted, I learned some really fancy stuff in college. According to my probability and statistics class that also would mean that your goal is to "not lose money." Did I lose you? I hope not.

The bottom line is that you don't want to lose money. Therefore, don't buy companies that are losing money.

An example of a Chinese company that has been losing money is Heckmann Corp. ( HEK) There are all sorts of companies like Heckmann out there that are losing money. The stock market is like a store. It doesn't force you to own or buy anything (unless you're a mutual fund). If you don't like any of the deals at the store, don't buy.

Step 2: Figure out who (not) to listen to.

Berkshire Hathaway's ( BRK.A) annual meeting is also called "Woodstock for Capitalists." Basically, Warren Buffett, who invests through Berkshire, has a legacy of beating the market by not making dumb decisions. Listen to people that do what you want to do. In the realm of investing, Buffett, Joel Greenblatt, Peter Lynch and Benjamin Graham should give you a good start. People (in sports, business, life, whatever) who aren't great at what they do have a tendency to make a living commenting on:

1. What might happen by reading historical charts, tea leaves, or the stars.

2. What is happening.

3. What just happened five minutes ago.

4. What happened today.

5. What happened so far this year.

6. What the "greats" are doing or did according to their latest filings.

The bottom line is that you don't want to learn from commentators.

An example of a Chinese company that gets so much coverage that it's likely to be overpriced is Baidu ( BIDU). It's roughly 4.7 times as expensive as Sohu.com ( SOHU), even though Sohu has been growing faster. I would recommend reading about Lynch and his use of the price/earnings to growth ratio if this confuses you.

Step 3: Figure out when (not) to take action.

Back in December when I called the bottom of the Hang Seng would have been the best time to buy Shanghai or Hong Kong stocks. The good news is that there are still stocks out there with more than 1,000% upside potential. When you have a country growing gross domestic product at a faster rate than the rest of the world, that is forecast to continue that growth, and is priced cheaper than the rest of the world on average, it's time to buy. In my opinion, it's still a great time to buy China.

Buffett's theory is that risk comes from not knowing what you're doing. I'd say that's over the head of most people and doesn't readily apply in the realm of finance. I agree that in life risk comes from not knowing what you're doing. In finance, however, risk comes from overpaying. Buffett sells only the obviously overvalued and otherwise holds and refuses to purchase unless he is confident that over time it's nearly impossible for him to lose money.

The bottom line is that it's time to buy when everyone else is afraid and selling and "uncommon sense" indicates that not buying is foolish.

Instead of giving a couple of stock ideas here, I'll say that when people are afraid and selling they may be selling for a reason. There are a lot of worthless companies trading at positive share prices, so be careful and figure out how to avoid these companies. Build a framework that finds companies with high intrinsic values and low share prices.

All work isn't created equal. Some people feel like they are getting work done by trading things back and forth. The level to which you are busy is in no way, shape or form directly related to the value you are adding to an organization. It's not what you do, but how you do it that is important. I learned this lesson the hard way when I wanted to get work done on a construction site and my boss had me dig a large hole just to "keep me busy." Valuable lesson: It was a worthless hole.

Over the next couple weeks, I'm going to highlight several Chinese companies that meet my investing criteria by simply avoiding the silly mistakes of the average investor. I know of profitable companies trading at steep discounts to their multi-million dollar backlog, and companies trading at price-to-earnings ratios of less than 5 with triple-digit growth, and more. Unfortunately, these deals don't last forever, much like the doorbuster deals that you see on sales the day after Thanksgiving. Once they're gone, they're gone.

Bradford and his shareholders don't own any of the companies mentioned, but AWCI might be exposed to some of his companies. Bradford is a Purdue Industrial Engineer pursuing his MBA and trading his entire tuition in the stock market as well as the tuition of his roomate. His life goals are to efficiently allocate capital: mental, physical, financial, emotional.

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