Another one for the pot

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Your China pot should be no more than 10 to 20 per cent of your portfolio and should be spread over at least five shares. The companies we are seeking will be quoted in Hong Kong with Chinese management and substantial facilities in China to take advantage of the cheap labour costs - one-twentieth of the US - and the potentially massive consumer market.

S Megga is a leading manufacturer of high-quality cordless telephones and fax machines. About 70 per cent of sales come from AT&T in the US, 10 per cent from China and the balance from North America, Europe and Asia.

Megga recently entered a 24:76 joint venture, HKJV, with AT&T covering the Asia-Pacific region. HKJV has in turn made a 75:25 deal with the Chinese ministry of posts and telecommunications.

The deal with the ministry is proof of Megga's guanxi - the Chinese word for the right connections, an essential ingredient for any investment in China. The chairman of Megga, Leung Ray Man, owns 29.5 per cent of the company and, as further evidence of guanxi, the Dongguan city government owns a similar percentage. The remaining 41 per cent of the pounds 85m-plus market capitalisation is owned by the investing public and institutions.

Megga's production is 70 per cent based in China and 30 per cent in Malaysia. It has spare capacity to meet rapidly expanding demand, but plans to build a further factory.

Following a placement of shares and the establishment of a substantial loan facility it can finance its expansion and is unlikely to make any further calls for cash in the near future. It has also diversified into property in Dongguan, a large part of which is pre-sold.

Smith New Court, in an April circular, estimates earnings per share at 18 cents for the year ending 30 June. For the following year, Smith's anticipate earnings of 24 cents and another broker, South China Securities, makes a similar estimate.

Future earnings growth should therefore be 33 per cent and, at the present price of HKdollars 2.25, the prospective p/e ratio for 1994 is 9.4. The price-earnings growth factor - the prospective multiple divided by the future growth rate - is therefore a very attractive 0.3 compared with 1.2 for the average UK growth share.

Investing in China can be risky because the government is worried about the rising inflation rate. There is no doubt that a clampdown will come soon and interest rates are likely to be raised. However, the Chinese stop is our go, and after an inevitable hiccup you want to be positioned in a few companies that will benefit from China's potentially massive future expansion.

During the next few months I will recommend three more shares to complete your China pot and I will keep you advised about them from time to time.

Remember, Hong Kong shares are subject to cash settlement within two days. Your broker will obtain a better price for you by dealing direct with a Hong Kong broker instead of a market-maker in London.

The author is an active investor who may hold any shares he recommends in this column. Shares can go down as well as up. He has agreed not to deal in a share within six weeks before and after any mention in this column.