Two China Stocks That Buffett Could Like

• ByJohn Reese, RealMoney Contributor
• On 4:00 pm EDT, Monday September 28, 2009

When one discusses countries that grow rapidly, there's China and then there is, well, everyone else. Year after year, in recession or in boom times, China grows and grows and grows. The Asian Development Bank (ADB) just released a report that says China will grow an impressive 8.2% in 2009. This is up 1.2 percentage points from the bank's prediction as recently as March.

China's growth is only getting stronger. The ADB, in fact, predicts that in 2010, China will grow even faster, 8.9%. And all of this growth is occurring with fairly moderate inflation -- 3% projected for 2009 and 2010. Admittedly, this growth is down from the blistering rate seen before the global recession. The Economist reports that China's growth rate in 2007 was 13%.

What is notable, though, is that China is able to generate high growth through thick and thin. Almost any other country in the world would love an 8%-plus growth rate in good times. To have such a rate during an economic downturn is remarkable.

China's growth and its ability to sustain growth is why I decided to look for Chinese companies that pass scrutiny with the guru strategies I use. These strategies are based on the investment approaches of some of history's greatest investors, and I figure a Chinese company that is well positioned in China and is also well thought of by any of the guru strategies is a company worthy of your investment consideration. I found two such companies, and they get passing grades from the strategy based on perhaps Wall Street's greatest investor, Warren Buffett.

One of these is China Mobile. Lest you think that Americans are the biggest lovers of mobile phones, their ardor is fairly tame compared with that of the Chinese. No country in the world has more cell-phone users than China. I've seen various numbers for how many such users there are in China, but it seems the country contains at least 700 million of them.

If you don't know of China Mobile, then you really are unfamiliar with the Chinese mobile phone market. This company reportedly controls 72% of China's cell-phone market. If I am correct in saying the number of Chinese with cell phones numbers about 700 million, there is still plenty of room for growth, since the country's population is at least 1.3 billion. China Mobile's subscriber base is about 500 million.

This brings me to the Buffett strategy's analysis of China Mobile. The first variable that this strategy requires is that the company be in a strong market position. Well, that goes without saying for China Mobile and its huge market share. The strategy then looks for consistency of earnings gains. China Mobile has enjoyed great consistency -- EPS has increased in each of the past 10 years. Another big plus is its low debt level. On the basis of its most recent annual earnings, the company could pay off its debt in a bit over a month.

There are other factors the strategy likes about the company, including its high return on equity (23.1% averaged over the past 10 years), high return on capital (20.8% averaged over the past 10 years) and management's ability to earn an impressive 26.5% on returned earnings.

All of this is great, but still does not necessarily mean the stock is priced right and is therefore worth your investment. The strategy uses two ways to calculate how much investors could expect to earn on average over the next 10 years, then averages these two numbers. It wants investors to have a reasonable expectation of earning about 15% or more. That's a hurdle China Mobile easily gets over, as the projected average return to investors is 18.0%.

The other company that the Buffett strategy approves at this time is Jinpan International. This company designs, manufactures and sells cast resin transformers for voltage distribution equipment in China, and it calls itself one of the largest such manufacturers in the world. The equipment is used in large projects such as factories, real estate developments, airports and subway systems.

Being a dominant player is, as I noted above, a prerequisite for obtaining a passing grade from the Buffett strategy, and Jinpan is a dominant player in its market. It also has admirably consistent earnings growth, with EPS increasing in each of the past 10 years. China Mobile had little debt, and that was good. Jinpan does China Mobile one better, by having no long-term debt. Some other positive signs: an acceptable return on equity and capital, both 14.4%, positive free cash flow per year, and a management that has been earning 23.0% on retain earnings. Though Jinpan's expected rate of return over the next decade is lower than China Mobile's, it is still a perfectly acceptable 15.3%.

Both of these companies are well positioned to take advantage of China's growth. China Mobile benefits from the Chinese people's desire for phone service, while Jinpan takes advantage of China's economic development and the accompanying increased demand for electricity. Plus, both companies perform well financially and get the approval of the Buffett strategy. If you want to diversify your portfolio so it includes Chinese businesses -- and I believe this is a good strategy -- these are two companies you might want to consider including.

Buzz up!