For the nimble investor, opportunity in China is undeniable

For months now, some of the most drool-worthy returns on Earth have been in a corner of the markets rarely frequented by Canadians – mainland China, where local investors are piling into stock markets and bidding up massive price gains.

The Shanghai Composite Index is up 75 per cent in the past six months alone. Not even the tech-era Nasdaq index, with all its froth, could match that.

In years past, Chinese stocks might have been cause for envious speculation, but not any more – China, after all, has long been impenetrable to individual traders, allowing investments only through select funds. But beginning last November, a program called the Hong Kong Stock Connect created a bridge for money from all over the world to flow into the Shanghai market through Hong Kong. Regulators are working to do the same for China's Shenzhen market.

Not every Chinese stock is open to foreign investors: only those on the top indexes. But that still amounts to more than 560 in Shanghai, meaning many shares are now just a click away for foreign investors who have a broker in Hong Kong.

The question: Is that a leap too far? After all, extraordinary gains inevitably raise worries that the air will come whistling out of a market puffed full of high hopes. The Shanghai market's overall valuation, at 24 times forward earnings, is already considerably higher than major North American and European indexes, and a third of Shanghai stocks with earnings forecasts are now trading at a lofty 50 times earnings or even higher.

To make matters even less appealing, the quality of Chinese companies (and their accounting) can be questionable. China's slowing economic growth isn't helping prospects, either.

"Misallocation of capital is still rampant in some industries and bank balance sheets continue to carry unproductive assets," says Suranjan Mukherjee, a portfolio manager with Fidelity Worldwide Investment. Still, there are enough good companies that Shanghai provides "the perfect recipe for stock picking," he says.

Then there's the bigger picture. "Long term, investors cannot stay out of the Chinese market. Because what we are seeing is the unfolding of a whole series of structural reforms in China" that, together, will create an "improvement of the whole system," says Chi Lo, senior economist for Greater China with BNP Paribas Investment Partners. Along with that will come a re-evaluation of Chinese assets that stands to add substantial value, he believes.

It's worth noting, though, that speculation is rampant about Chinese government interference in stock prices. Some observers believe Beijing wants the market to stay high to maintain social stability, or to serve as a welcome environment for capital raised by the nation's state-owned enterprises.

Some of the most senior figures in the industry have warned that investors should brace themselves for bumpy rides ahead. But for those who are both nimble and willing to burrow into the details of individual Chinese companies, the opportunity is undeniably tempting.

"Is it a bubble – so do you sit close to the door? It might be overvalued already," says Bob Kwauk, a Beijing-based lawyer with Blakes, Cassels & Graydon. "But that doesn't mean you can't make more money. Because what happens if Shanghai goes to 6,000 points again?" (It's now just under 4,300; it peaked in 2007 near 6,000.) "Then you still have a healthy 30, 40 or 50 per cent profit to make."

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