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Are China Stocks a Good Bet as Economy Slows? 5 Picks

Swarup Gupta

Fresh estimates from an official think tank indicate that China’s economy will grow at a slower rate in the second quarter. This is keeping with recently released economic reports which reveal that key indicators slipped in April. Officials have also stated at several points that they would be willing to accept a slower pace of growth as China attempts to mitigate risk in its economy.

Yet, foreign investors remain enthusiastic about China, choosing to focus on its inherent and emerging strengths instead of dwelling on its weaknesses. Among these positives are a stable yuan, strong earnings and low valuations, which make investing in stocks from China an extremely attractive proposition.

Growth Slated to Slow in Second Quarter

According to an article published in a state owned newspaper on Saturday, China’s GDP will decline to 6.8% in the second quarter of this year. Such a figure is lower than the first quarter’s growth rate of 6.9%. The projection released by government think tank State Information Center also estimates that consumer inflation will come in at around 1.4% during this period while producer prices will increase by 6.5%.

Taken together, this represents a picture of slower, yet stable growth. Recently released economic data seem to support such a trend. In April, industrial production declined to a yearly pace of 6.5% from the rate of 7.6% recorded in March. Similarly, retail sales declined from 10.9% to 10.7%. Growth in fixed asset investment growth slowed to a pace of 8.9% for the first four months of the year compared to the first quarter’s rate of 9.2%. 

Foreign Investors Remain Bullish

It has been widely accepted that a slowdown in growth is a natural consequence of the government’s attempts to reduce China’s financial risks. Speculation in the property market and alarming debt levels are being addressed through a variety of regulatory measures. The extent of the problem can be gauged from the fact China’s credit to GDP ratio increased from 141% in 2009 to 260% in 2016.

But foreign investors, including influential financial majors such as Morgan Stanley continue to maintain a bullish stance on China. They point to the rise of the MSCI China Index which has neared its highest level in 22 months. This is a remarkable performance given that it has recovered by nearly 41% from the low it touched in Feb 2016.

Several factors are responsible for the optimism of foreign investors. First, the yuan is passing through its most stable period since 2015 when it was devalued.

Additionally, earnings for China’s companies, including those listed on both the MSCI China index and the Shanghai Composite are projected to increase by the greatest extent in seven years. China’s stocks are also undervalued compared to their global counterparts. Such an argument in borne out by the fact that the MSCI China index currently trades at a 24% discount to the MSCI All-Country World Index.

Our Choices

Foreign investors remain bullish about the prospects of China’s stocks despite a projected slowdown in growth. A combination of attractive valuations, strong earnings performance and a stable yuan are the reasons for their optimism.

Picking select stocks from China looks like a smart option at this point. However, picking winning stocks may prove to be difficult.

This is where our VGM score comes in. Here V stands for Value, G for Growth and M for Momentum and the score is a weighted combination of these three scores. Such a score allows you to eliminate the negative aspects of stocks and select winners. However, it is important to keep in mind that each Style Score will carry a different weight while arriving at a VGM score. 

YY Inc. YY is a communication social platform, which engages users in online group activities through voice, text and video.

YY has a Zacks Rank #1 (Strong Buy) and a VGM Score of A. The company has expected earnings growth of 35.5% for the current year. Its earnings estimate for the current year has improved by 21.5% over the last 30 days.

Yirendai Ltd. YRD is the operator of an online consumer finance platform.

Yirendai has a Zacks Rank #1 and a VGM Score of A. The company has expected earnings growth of 5.9% for the current year. The forward price-to-earnings (P/E) ratio for the current financial year (F1) is 7.80, lower than the industry average of 14.89.

JD.com, Inc. JD is a major e-commerce company operating in China.

JD.com has a VGM Score of B. The company has expected earnings growth of more than 100% for the current year. Its earnings estimate for the current year has improved by more than 100% over the last 30 days. The stock has a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Autohome Inc. ATHM is an online provider of automobile related content within China.

Autohome has a Zacks Rank #2 (Buy) and a VGM Score of B. The company has expected earnings growth of 25.9% for the current year. Its earnings estimate for the current year has improved by 3.8% over the last 60 days.

Yum China Holdings, Inc. YUMC is a licensee of Yum! Brands, primarily in mainland China.

Yum China Holdings has a Zacks Rank #2 and a VGM Score of B. The company has expected earnings growth of 10.7% for the current year.

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