Why Chinese Stocks Look Like Bargains

NEW YORK ( TheStreet ) -- With investors fretting about emerging markets, Chinese stocks have languished. During the past year, China mutual funds returned 5.4%, compared to 21.9% for the S&P 500, according to Morningstar.

Now some portfolio managers argue the Chinese shares are at bargain levels. Anthony Cragg, portfolio manager of Wells Fargo Advantage Asia Pacific (WFAAX), says the Chinese market's price-earnings multiple has dipped to 9 from the high above 20 that was recorded before the financial crisis. "China has gone from being the most expensive large emerging market to one of the very cheapest," he says.

Investors have fled emerging markets because of fears about weakening currencies and deteriorating trade balances. But portfolio managers argue China has been unfairly tarred with problems that afflict other countries. While Turkey and Brazil suffer from weakening trade balances, China remains an export powerhouse with a huge trade surplus.

At a time when many governments worry about collapsing currencies, the Chinese regime has labored to insure that its renminbi appreciates only slowly. "Over the years, most emerging markets crises have been the result of currency problems," says Robert Bao, portfolio manager of Fidelity China Region (FHKCX). "But the Chinese currency is stable."

Make no mistake, the Chinese economy is slowing down. During the past decade, annual GDP growth rates sometimes exceeded 10% as the country raced to modernize. But now that China is the second-largest economy in the world, the growth rate has dipped to 7.7%. While many investors worry about the slowdown, bullish portfolio managers note that GDP growth is still among the fastest in the world. The managers argue the Chinese regime will continue stimulating the economy to maintain a healthy job market.

To obtain a dose of relatively steady Chinese stocks, consider Guinness Atkinson Asia Pacific Dividend (GAADX). Portfolio manager Edmund Harriss focuses on high-quality companies that have delivered reliable returns on investment for at least the past eight years. Holdings include blue-chips that have proven their ability to weather downturns.

The fund has 35% of its assets in China and Hong Kong. The cautious portfolio tends to outperform in downturns and lag in rallies. During the past five years, the fund returned 17.9% annually.

A holding is China Mobile (CHL), a telecom company that serves 700 million customers. "This is a dominant provider that has been able to increase its dividend payout over time," says Harriss.

While the overall China markets have stagnated, e-commerce stocks have soared. That has provided a boost for Oberweis China Opportunities (OBCHX), which focuses on small- and mid-cap growth stocks. During the past year, Oberweis returned an eye-popping 50.8%.

Portfolio manager John Wong says that e-commerce currently accounts for 6% of all retail sales in China. The figure will climb to 10% by the end of next year as more consumers in rural areas come to rely on the Internet. Wong holds Vipshop (VIPS), a discount online retailer that sells apparel and cosmetics brands. "The e-commerce growth rates will continue to be strong for the next couple years," says Wong.

Fidelity China Region seeks modestly priced stocks with above-average growth prospects. Portfolio manager Robert Bao often favors rock-solid businesses. "We emphasize companies with strong balance sheets and superior cash flows," he says.

During the past five years, Fidelity returned 20.1% annually, outdoing its average peer by 3.8 percentage points. In 2013, the fund scored big gains with Tencent (TCEHY), an Internet giant. The company provides messaging services and social networks.

For a broader Asian fund, consider Wells Fargo Advantage Asia Pacific, which has 19% of assets in China. Portfolio manager Anthony Cragg favors growing companies that sell at reasonable prices. He takes stocks of all sizes. During the past five years, the fund returned 15.9%, outdoing its average peer by half a percentage point.

Cragg is willing to take contrarian positions. At the moment he has a stake in Industrial and Commercial Bank of China (IDCBY), which has a price-earnings ratio of 5. Investors have fled Chinese banks because they worry about debts in the country's shadow banking system. Cragg argues the fears are overdone. "The Chinese government is coming to grips with the banking problems," he says.

At the time of publication the author had no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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