DEER Deer Consumer Products, Inc. (MM)

Anyone who's been paying attention to the Chinese economy for the last few years knows the country is growing by leaps and bounds. Even after economists recently downgraded growth projections for the far-east juggernaut, Q2 GDP is still expected to clock in at an impressive 9%. So it probably sounds like a great time to take advantage of the trend and buy some Chinese stocks, right? Not so fast.

Chinese Stocks Losing Confidence

On the heels of some very high-profile hijinx and shenanigans, Chinese stocks are dealing with serious credibility issues. The biggest offenders have been of the reverse merger variety, when a privately owned foreign company scoops up a distressed company's public charter and merges the two together. This is almost like something out of a science fiction movie, where an evil alien being invades a host body and all sorts of fun things happen. But this isn't science fiction, its verifiably authentic, with a total of 370 reverse mergers hitting the exchanges since 2004.

But while the reverse merger is totally legal and compliant, its the post-reverse-merger behavior where things start getting sketchy. A growing number of reverse-merger Chinese companies have been exposed as being fraudulent, with their activities in question ranging from manipulating accounting standards to having fake stores, fake customers, fake sales and fake products.

Buyer Beware

Take Deer Consumer Products (DEER), whose share price recently plunged from $11 to $6 on suspicion it was manipulating revenue, earnings and margins. How about China MediaExpress Holdings, Inc. (CCME), a Chinese advertising company whose biggest customer was found to not even exist. CCME has since taken a nose dive, falling from $12.25 to just pennies. The list goes on, but as you can see, buying shares in a Chinese reverse-merger stock is risky business.

So what about just skipping reverse mergers and going with a regular listing? Here's the problem with that; the contagion is spreading, with "regularly" listed Longtop Financial Technologies (LFT), recently accused of making false statements and manipulating its balance sheet to boost margins. Shares have since plunged close to 50%, falling from $35 to $18.

Go American

But just because reverse-merger and regular Chinese stocks are lacking credibility doesn't mean you have to sit on the sidelines while the Chinese growth story rages on. A great way to invest in China is buying American companies with heavy Asian exposure, providing a very nice balance of regulatory transparency and growth. Let's go ahead and take a look at our top four top picks in the category.

Top 4 Stocks for Chinese Growth

Caterpillar Corp (CAT) has been cashing in on the Chinese story, as surging infrastructure growth drives demand for its heavy machinery. This Zacks # 1 rank stock has an average earnings surprise of 21% over the last four quarters, with its most recent surprise clocking in at 40%. With a discounted forward P/E of 15X, shares trade at a discount to their peer average.

Yum Brands, Inc. (YUM) has been a big Chinese success story over the last few years, currently operating over 3,330 KFC's and more than 650 Pizza Huts. But in spite of the gains, the analysts believe the story is still intact, projecting 12% earnings growth next year. And with a target dividend payout ratio, you will be getting paid to own a growth stock.

Sticking with fast food, McDonalds Corp (MCD) is also tapping into the Chinese growth story, recently announcing its intentions to boost its investments in China by 40% in 2011. After opening 166 new stores in China in 2010, bringing its total to 1,300, management plans to have a total of 2,000 by 2013. You also get paid to own this Zacks #2 rank stock, paying a solid 3% dividend.

Potash Corp (POT) is a fertilizer company with strong sales out of China and an eye towards more growth in the region. The company has an average earnings surprise of 14% over the last four quarters and a high industry rank of 76 out of 265.

So as you can see, investing in Chinese stocks can be risky, which is why buying shares of American companies to capitalize on the Chinese growth story makes a lot of sense.

Michael Vodicka is the Momentum Stock Strategist for Zacks.com. He is also the Editor in charge of the Zacks Momentum Trader Service.
 
CATERPILLAR INC (CAT): Free Stock Analysis Report
 
CHINA MEDIAEXPR (CCME): Free Stock Analysis Report
 
DEER CONSUMER (DEER): Free Stock Analysis Report
 
LONGTOP FIN-ADR (LFT): Free Stock Analysis Report
 
MCDONALDS CORP (MCD): Free Stock Analysis Report
 
POTASH SASK (POT): Free Stock Analysis Report
 
YUM! BRANDS INC (YUM): Free Stock Analysis Report
 
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