The new New World

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The Independent Online
In this column, I have recommended shares like Amersham International, Sage and British Data Management. These companies all have strong balance sheets with little or no debt, and low p/e ratios in relation to their above-average growth rates. They also share another very important attribute - all are new economy companies, free from the baggage of yesterday, making the products and providing the services of tomorrow.

New economy companies are usually in immature industries that are still growing fast. Old economy companies are in mature industries with too many competitors and limited demand. The difference between sophisticated new drugs for previously incurable diseases and bicarbonate of soda; advanced computer software and conventional accounting stationery; micro-storage of records by computer and filing cabinets.

I often wonder what a very commercial alien, landing on Earth for the first time, would conclude from a survey of the world's economies. I very much doubt if any country in Europe would feature strongly in his investment portfolio. The Far East would be the area that attracted him most and, in particular, China.

The recent progress of China, which I would describe as a new world economy, compares very favourably with any country in the old world. For example, during the past 10 years, China's GDP has been expanding at an average rate of more than 9 per cent per annum. Early in the next century, China could overtake Japan and become the second- largest trading nation in the world.

To my mind, the interesting point is that most people seem to invest, almost automatically, in the stock markets of their own country. They read about national companies in their daily newspapers and they use the products and services being provided by them. This makes them feel that they are investing in businesses that are both safe and familiar. Their investment policy can best be described as an accident of birth.

Investing directly in China is now possible for foreigners through the Shanghai and Shenzhen stock exchanges. However, the Chinese companies quoted there are limited in number and multiples are high - the present average is about 18 times prospective earnings. An alternative method of participating in China's growth is through Hong Kong by investing in companies with manufacturing facilities on the mainland. Companies that would benefit directly from China's cheap labour costs (5 per cent of those in the US and far cheaper than Japan) and from the fast-growing and potentially massive Chinese consumer market.

The average multiple of the Hong Kong market as a whole is about 12.5 times this year's earnings. Not expensive in relation to earnings, which have grown by more than 16 per cent per annum during the past 10 exceptional years. You would naturally imagine that companies with big investments in China (the new Hong Kong) had higher multiples than companies with property and other interests mainly in Hong Kong itself (the old Hong Kong). You will be surprised to learn that the smaller companies, among the so-called red chips, are remarkably cheap, on multiples far lower than the market average.

Before you say that it all sounds too simple, let me tell you about some of the snags. Deng Xiaoping, the architect of the economic revolution, is 88 and frail. China's economy is overheating, and inflation is rampant and has to be slowed down. There are bound to be setbacks during the coming rounds of talks between Governor Chris Patten of Hong Kong and the Chinese government, and the Americans may, at some time, impose unacceptable conditions on the renewal of most favoured nation trading terms for China.

These risks worry me, but not unduly. Mr Deng's successors will still want to attract foreign capital and, as they say in China, 'the party line is the bottom line'; a slowdown in the Chinese economy is very necessary, but their stop is our go; the Patten talks are an irrelevant sideshow to the business relationships that are naturally developing between mainland China and the new Hong Kong companies; and I believe that President Bill Clinton will find a politically acceptable formula for continuing to renew China's MFN status. Also, all the risks are very much reflected in market prices - where else can you buy a share on a multiple of eight growing at 40 per cent per annum, with the tailwind of Chinese future growth behind you?

I am sure that our alien would decide to invest in China. In case you want to join him, I will show you the best way next week.

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