Morningstar Advisor - Summer 2007 - (Page 64)

Sector Rap MW: Government ownership represents as much as 65% to 85% of some of the companies I’ve analyzed. Paul Larson: The government holds all the cards. It’s hard to overstate that point. The government will dictate both growth and risk, and it can be hard to handicap the future actions of an all-powerful Chinese government. SM: How do we account for this risk in our stock analysis? MC: We demand a higher margin of safety to invest in Chinese stocks. We also use a higher cost of equity in our discounted cash-flow models to account for the risks of investing in China. At times, we have also made assumptions about future governmental actions. For example, the government has consistently subsidized China Petroleum & Chemical ADR SNP in the past, so in our forecasts of future cash flows, we assume they will continue to do so in the future. SB: We also try to understand where and how the government is involved. It’s important to understand management’s position within the party to assess the firm’s future prospects. SM: Chinese firms aren’t subject to the kind of disclosure laws that we have here in the United States. How has that influenced the way we research Chinese stocks? SB: Most importantly, we put people on the ground there. MC: Our analysts visit firms and speak with management in their native language. That way we can hopefully build a relationship, which should help us read between the lines in the financial reports. SB: Lack of disclosure laws can also work in our favor at times. Managers don’t have to worry about offhandedly running afoul of dis- China ETFs Fund Inception Expense Ratio (%) YTD Worst 3 Mo. Return (%) Return (%) % In Top 10 Holdings Avg. Mkt. Cap ($mil) iShares FTSE/Xinhua China FXI PowerShares Halter USX PGJ SPDR S&P China GXC Data as of June 30, 2007 10-05-04 12-09-04 03-19-07 0.74 0.71 0.59 15.08 24.07 33.81 3.41 2.44 — 60.32 48.64 50.48 64,798 10.129 23,901 Watchlist: Multinationals with Exposure to China Company Morningstar Rating Business Risk Fair Value ($) Consider Buying ($) Consider Selling ($) GE GE* Caterpillar CAT Siemens ADR SI* ABB ADR ABB Data as of June 30, 2007 *This stock was under review at press time. — QQQ — QQQ Avg Avg Avg Avg — 73.00 — 26.00 — 56.30 — 20.00 — 91.50 — 32.60 closure regulations, so sometimes they may be more candid. SM: Chinese stock listings are complicated. Could you briefly explain them? SB: First, some Chinese firms have ADRs that are listed on U.S. stock exchanges, such as PetroChina PTR, China Mobile CHL, and CNOOC CEO. [Morris: PowerShares Golden Dragon Halter USX China PGJ invests exclusively in ADRs.] These companies are subject to Securities and Exchange Commission disclosure regulations. Chinese companies are also listed on the Hong Kong Stock Exchange. [Morris: The stocks included in iShares FTSE Xinhua 25 Index FXI and SPDR S&P China GXC are listed on this exchange.] While not as strict as SEC regulations, the disclosure laws for firms listed on this exchange are respectable because the exchange had a long history under British rule. Finally, Chinese stocks are also listed on the Shanghai Stock Exchange. This is an extremely inefficient market, and it’s subject to very little regulation. SM: In your opinion, what’s the best way for investors to make a play on the China growth story? MW: If they existed, I’d buy long-dated puts on the Chinese stock market today because valuations looks so inflated. But at the same time, I’d invest in multinationals that have exposure to China, such as GE GE, Caterpillar CAT, Siemens SI, and ABB ADR ABB. They have better corporate governance, better disclosure, and much more attractive valuations. SB: I agree. Right now, there are better ways to invest in China than directly in Chinese stocks. K Sonya Morris, CPA, is a fund analyst with Morningstar and editor of Morningstar ETFInvestor, a monthly newsletter that covers 150 ETFs. This article appeared in the May issue of Morningstar ETFInvestor. Subscribe at: http://www.morningstar.com/goto/Adv37 64 Morningstar Advisor Summer 2007 http://www.morningstar.com/goto/Adv37

Table of Contents Feed for the Digital Edition of Morningstar Advisor - Summer 2007

Morningstar Advisor - Summer 2007 Contents Letter from the Publisher Get to Know the Bond “All-Stars” Research Briefs Our Stewardship Test Gets Tougher Save It for Later Too Many Oranges Best of Both Worlds No Two Clients Are Alike When It Comes to VAs, It’s Seller Beware Hands On: Finding the Suitable Fund Share Class for Your Client Fund Style Can Drift Off Course Sticking to Their Style, Through Thick and Thin Marathon Man Growth, With a Chaser A Menu of Ideas to Fill Five Market Baskets Funds: Finding Funds with Conviction Stocks: So You Say You Want Income? All Eyes on China Mutual Fund Analyst Picks Undervalued Stocks Most Popular Variable Annuities What’s New at Morningstar and on the Web The Advisor’s Economic Moat

Morningstar Advisor - Summer 2007

For optimal viewing of this digital publication, please enable JavaScript and then refresh the page. If you would like to try to load the digital publication without using Flash Player detection, please click here.