Tags: China, Martin Hutchinson

Four Ways to Profit From the "Other China"

By , Money Morning •

By Martin Hutchinson
Contributing Editor

China's Shanghai SSE Composite Index soared 97% in 2007, and is trading at 30 times earnings. Taiwan's TSEC Taiwan 50 Index was up 7% in 2007, and is trading at 13 times earnings. Yet the Kuomintang victory in Taiwan's just-completed legislative election yet again demonstrates an important truth: Taiwan is the "China" to buy.

Let me explain why.

First, there's no question that the Taiwanese economy is highly dependent on China. Indeed, fully 38% of Taiwan's exports go to China - including Hong Kong - while 16% of Taiwan's imports originate on the mainland.

What's more, some of Taiwan's most important companies - such as Taiwan Semiconductor Manufacturing Co. Ltd. (TSM) and Hon Hai Precision Industries (HNHPF) - do a great deal of their manufacturing in China, since labor costs are lower there. Essentially, the intellectual input comes from Taiwan's superb education system and highly competitive tech sector, while China provides the skilled labor at low cost.

That means Taiwan's big business generally supports the Kuomintang party, the winners over the incumbent Democratic Progressive Party in Saturday's legislative elections by taking 81 seats, or 51% of the vote. The DPP held onto 27 seats, or 37% of the vote.

The Political Evolution of Taiwan

Chiang Kai-shek who migrated to Taiwan after the 1949 fall of China to Mao Zedong's communists, today believe in closer relations with China, and oppose Taiwan independence, the principal platform of the DPP. That makes them favored by the Chinese government, and is likely to produce warmer relations with China, compared to the periods of chill that have occurred during DPP President Chen Shui-ban's terms in office since 2000.

That doesn't mean the DPP is an anti-business party. Far from it, in fact. In spite of the fallout from the bursting of the high-tech-stock bubble back in 2000, Taiwan's growth under Chen advanced at a steady 4% to 5% annual clip - and accelerated to nearly 7% last year, thanks to the worldwide economic boom.

Taiwan's inflation rate is a paltry 3%, government spending accounts for a mere 21% of the country's economic activity and the country runs a hefty balance-of-payments surplus. Unlike China, there are no signs of major problems in Taiwan's banking system. Thus, even though Taiwan's growth rate is lower than China's "official" growth rate, the greater stability of Taiwan's economy ought to make the shares of Taiwan-based companies trade at a premium to those based in China.

Unfortunately, that's not the case. Instead, Taipei trades at less than half the earnings multiple of Shanghai, and the Taiwan stock market failed to participate in the rapid 2007 run-up seen by stock markets in China and several other Asian countries. With a per capita income of nearly $30,000, and a productivity growth rate of 4% [more than double the rates enjoyed by Europe and the United States], Taiwan is one of the world's best bargains.

If the relations between China and Taiwan improve enough under the newly elected Kuomintang government to cause the economic dealings between the two countries to accelerate, Taiwan could see a nice run-up in its stock prices - even if the other Asian markets are rather dull this year.

More Ways to Profit

One highly effective way to play the Taiwan market is with the iShares MSCI Taiwan Index (EWT), an exchange-traded fund (ETF) that's currently trading at only 13 times earnings and yielding a worthwhile 2.6%. Taiwan Semiconductor, trading at 15 times earnings and yielding 4%, is the top Taiwan blue-chip stock. It's the world's largest semiconductor fabricator, producing approximately 7.15 million wafers in 2006, distributing its products in the United States, Europe, Japan, China, Korea and India, among others.

Hon Hai is a higher-rated stock, trading at 19 times earnings and with a yield of 1.5%. But as the manufacturer of the Mac mini, the iPhone and the iPod for Apple Inc. (AAPL), cell phones for Nokia Corp. (NOK), and motherboards for Intel Corp. (INTC), it has a diverse customer base and a great business model. The fact that its also got a contract with Microsoft Corp. (MSFT), Nintendo Co. Ltd. (NTDOY) and Sony Corp. (SNE) to manufacture all three of the major gaming-system consoles now dominating world markets underscores the market power that Hon Hai possesses as the biggest electronics manufacturer on the planet.

Finally, you might look at Siliconware Precision Industries (SPIL), which yields a substantive 4.8%, and is trading on only 8.4 times projected 2008 earnings.

As you can see, these valuations are well below those available in slow-growing Western markets, let alone in China.

That underscores that Taiwan - the so-called "other China" - is an overlooked gem.

[Editor's Note: For a related story on Taiwan's political climate, please click here].

News and Related Story Links:

  • The Associated Press:
    Asian Markets Strong in 2007