U.S. News

China's Stocks Seen As Good Long-Term Bet Despite Volatility

Despite big declines in China's stock market on Wednesday, market pros say the region remains a solid long-term investment.

Securities regulators in China raised the tax on equities trading on Wednesday, increasing the rate of the "stamp tax" on stock trading to 0.3% from 0.1%, the Beijing's official news agency said. The move prompted a 6.5% decline in the Shanghai Composite Index.

The Chinese hike in the stamp duty, which is imposed on both sellers and buyers, follows repeated warnings from securities regulators regarding stock trading risks.

Rob Lutts, chief investment officer and founder of Cabot Money Management, told CNBC that Wednesday's big decline was an opportunity for U.S. investors to raise their exposure to the world's fastest growing economy.

"I think the China market is still a very sound place for people to invest," said Lutts. "You have to use a lot of discipline, you have to use your risk-management techniques, but I think it is a place that is really a substantial opportunity going forward."

"Most investors need to look at their small allocation they have to emerging economies on any big pullback like we're getting right here," he added. "They should be increasing their weightings there and I think they are going to be really pleased if they look down the road three to five years."

Cooling a Rising Market

China's central bank recently stepped up its efforts to cool its exponentially rising market on May 18 when it raised interest rates for the fourth time in 12 months, raised bank reserve requirements for the eighth time and widened the trading range on the yuan.

U.S.-China Similarities

Richard Gao, lead portfolio manager of the Matthews China Fund , said China is still a good long-term bet but stocks have gained too much too fast.

"Investing in China-related stocks, from a long-term perspective, is something we've always been positive on," Gao said. "But on the other hand, you have to be prepared for some volatility."

Speculative investors in China have been undeterred by sharp selloffs, most notably a 9% decline on Feb. 27 which erased about $140 billion of value. A day after Shanghai's largest one-day drop in a decade, investors jumped back in the market and sent stocks up 4%.

"This market is dominated by retail players and its valuation is one of the highest in the world, it's currently trading at 45 times earnings," said Gao, whose $1.2 billion mutual fund posted 2006 returns of 65%.

"A lot of people call it a bubble, I wouldn't describe it as a bubble but it definitely needs a sharp correction here," Gao added. "The correction is long overdue."

Valuation Gap

China's nascent stock market has been a retail-driven, speculative market since its inception in 1991, and the A-share market, open only to Chinese citizens and qualified large foreign investors, has seen valuations skyrocket as mainland investors pour money into stocks.

"Part of the reason why the A-share market has been so strong was because it was catching up to the performance of the real economy," said Gao.

Both Gao and Lutts said they prefer to invest in H-shares, or Chinese stocks listed in Hong Kong, where public disclosure and corporate governance are better.

"We think those shares are priced very reasonably," said Lutts.

Top Picks

The money manager also likes a handful of Chinese stocks listed on U.S. exchanges such as New Oriental Education , an educational services firm.

"Education is really important to the people of China and this company teaches people English," said Lutts. "This company is growing about 40% a year, it is expensive, but I think it is worth every penny of that expensive price."

Lutts also likes Internet search firm Baidu.com , which he calls the Google of China.

"It hasn't really hit the hockey stick of growth that Google did three or four years ago, but I think that's coming next year," he said.

"Most investors in the U.S. are underinvested in these emerging economies and we would just call them fast-growing economies, not emerging," Lutts said. "China has arrived, and is going to keep growing at very fast pace."

Peter Kang is a markets writer for CNBC.com. He can be reached at peter.kang@nbcuni.com.