"Are you sure this is one of the top hospitals in Beijing? The paint's peeling!"
This was my reaction after spending five minutes in a Chinese hospital. I asked our associate to do his best to snap some pictures without anyone noticing. (When your hosts give you permission to take pictures, they want you to photograph their brand-new, $3 million CT scanner... not the chipped paint.)
On our trip to China last month, my colleague Frank Curzio and I were interested in seeing the country's underdeveloped health care system. To an investor, "underdeveloped" just means it has a lot of room for growth.
And after seeing it for myself, I can say that there's A LOT of room for growth. For the record, the health care professionals we met were top-notch. The machines we saw were all new and about the same as you would see in the U.S. But the simple fact is that China's health care infrastructure is just starting to ramp up after decades of neglect.
Early last year, the Chinese government announced a $123 billion plan to establish universal health care for its population. That sounds like a lot of money... But it's not that much when you have over 1.3 billion people. Each person covered by the initial insurance system would receive a subsidy of $17 per year. (No, there are no zeroes missing there.)
Combined public and private health care spending in China is around 5% of gross domestic product (GDP) and about $120 per person. In the U.S., we spend 15% of GDP... and around $7,000 per person. China has a long road ahead to catch up to developed nations.
There are a few things investors need to understand before jumping into Chinese health care stocks...
Just as the nation's health care system is underdeveloped, so is the regulatory structure. The portfolio managers I talked to in China were unanimously cautious about any company outside of the pharmaceutical industry – which is the most developed market segment. Lack of support from institutional investors means high volatility for these stocks.
Right now, Chinese small-caps are out of favor. You can buy many high-quality names that have been beaten up recently.
Some of the best plays include Winner Medical (NASDAQ: WWIN, Stock Forum), which supplies the basic products new hospitals will be stocking up on, such as wound dressings, swabs, and surgical gowns. Another company to watch is China Medical (NASDAQ: CMED, Stock Forum), which produces a variety of diagnostic systems and testing kits that are widely used in hospitals.
As China's health care system evolves, these companies will be major beneficiaries. And as institutional investors get more comfortable with the environment, these names could see much higher valuations applied to their growing earnings.
Or... you can consider going the low-risk "American way" to invest here... by owning a U.S.-based company that will enjoy a big China kicker to its global business. For example, drug giant Pfizer (NYSE: PFE, Stock Forum) is the leader in market share in China. Analysts at Goldman Sachs estimate that Pfizer's China-based revenues could quadruple in the next five years. This would add $3 billion to its revenue.
China's growing health care system is a trend that will last for decades... It's worth paying attention to for a long time. There will be many small companies whose market caps jump from around $200 million to upwards of $1 billion as the market evolves... and there will be a lot of large companies, like Pfizer, that get a multibillion-dollar China boost.
Disclosure: The author does not hold positions in any of the stocks mentioned