Just buying China broadly will no longer deliver returns and investors now need to be selective with their mainland stock picks, said Michael Chiu, Asia Pacific equities investment director at HSBC.
"China is no longer a beta market. In the past, people would think about China as an emerging market. They would just close their eyes and buy China," but that no longer works, Chiu said at the AsianInvestor Southeast Asia Institutional Investor Forum in Singapore on Wednesday..
On Wednesday, the Shanghai Composite rallied more than 1 percent to about 2,260, a three-month high, however the index remains well below its all-time high of around 6,088, touched in 2007. The Shenzhen index tacked on 1.0 percent to close at about 1,064 Wednesday, not even close to its all-time high of around 1,550, touched in 2008.
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"If you look at the indexes, the market definitely isn't going back to its former glory yet," Chiu said. "If we just close our eyes and randomly pick a stock in MSCI China, most likely you'll get a stock that has gone down year-to-date."
Simply picking a sector, such as the continuing story of consumer growth, driven by rising urbanization, is also unlikely to succeed, he said, noting that while three of the top five MSCI China index performers are consumer plays, so are the index's three worst performers .
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But while the overall market may face headwinds to broad-based allocations, valuations – especially of the mainland-based A-share market – remain low, even after the recent share rally, he said.
"The valuation, no matter if you look at the price-to-earnings, price-to-book, or discounted cash flow, is cheap," he said. "There are some long-term structural problems in the banking sector, the property sector and the infrastructure sector, but a lot of these are already discounted in A-chip valuations. "
He likes the auto sector, noting it's trading around 10 to 15 times earnings, viewing it as not expensive when compared with volume growth of around 20-25 percent. The renewable energy sector is also a favorite, with some solar and wind power plays trading at less than 10 to 15 times earnings compared with the potential for more than 20 percent earnings growth.
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Even a "hated" sector, such as property, which faces government measures to cool sales prices, has some small-cap counters trading at 2-3 times earnings, Chiu noted. "There are some problems with the sector, but at 2-3 times price-to-earnings, they are quite cheap when adjusted for the growth potential," he said.
To be sure, some analysts are less discriminating, expecting a broad rally in China's market.
"China will be the best performing stock market in the world next year," Jonathan Pain, the author of market newsletter "The Pain Report," told CNBC.
He calls the China stock market's underperformance compared with the country's solid economic growth a "great conundrum," which he attributes to Western media predicting an imminent economic collapse on the mainland. But with that overhang fading, he views the market valuations as compelling and he is positive on the country's reform prospects.
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Goldman Sachs also expects broad gains in China shares in 2014. "External strength and stability at home ought to be enough to boost risk sentiment in China, particularly after several years of poor performance from Chinese equity indices," it said in a note.
It has an overweight call on the Hang Seng China Enterprises Index, setting an end-2014 target of 13,600, marking a nearly 20 percent rise from Wednesday's close at 11,368.78. It expects valuation multiples to expand and around 10 percent earnings-per-share growth.
— By CNBC's Leslie Shaffer. Follow her on Twitter: @LeslieShaffer1