Pat McKeough responds to many personal questions on specific stocks and other investment topics from the members of his Inner Circle. Every week, his comments and recommendations on the most intriguing questions of the past week go out to all Inner Circle members. And each week, we offer you one of the highlights from these Q&A sessions. While we reserve our buy-hold-sell advice for Inner Circle members, these excerpts provide a great deal of information and analysis on stocks we’ve covered for the Inner Circle.

This week, an Inner Circle member asked a question about one of China’s biggest budget hotel operators. In response, Pat gives an assessment of the potential rewards—and many risk factors—that come with investing in China.

Q: Pat: Pat: Can I have your views on 7 Days Group, the Chinese discount hotel operator? Thank you.

A: 7 Days Group (ADR, symbol SVN on Nasdaq; www.7daysinn.cn), is China’s second-biggest budget hotel operator.

The company’s hotels operate under the 7 Days Inn brand. It now has a total of 1,044 hotels, consisting of 417 hotels operated by the company and 627 franchised hotels managed by the company.

That gives it a total of 104,191 rooms across 162 cities. The company’s franchised hotels operate under the 7 Days Inn banner but are owned by third parties. 7 Days Group charges a fee to operate these hotels, including hiring managers and staff.

In the three months ended June 30, 2012, 7 Days Group’s revenue rose 27.1%, to $99.6 million from $78.1 million a year earlier. Earnings per American Depositary Receipt (ADR) rose to $0.19 from $0.17.

In the past year, the company has added a total of 425 hotels. It aims to have over 2,000 in operation by 2014. 7 Days Group plans to keep adding more managed hotels to its portfolio. It believes this will let it maintain its rapid growth without investing a lot of its own capital. It added 100 hotels in the first quarter of 2012, 94 of which were managed.

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Share price slips with Chinese growth rate at slowest pace in three years

7 Days Group’s share price is down lately, in part because China’s economy likely grew at a rate of just 7.7% in the second quarter of 2012. That’s the slowest pace in three years.

Still, the company is forecast to report earnings of $0.60 per ADR this year and $0.81 in 2013. The ADRs trade at 15.8 times this year’s estimate and 11.7 times next year’s estimate.

The company’s rapid growth holds a lot of opportunity for investors, but it also adds risk. The Chinese economy has strong prospects, as well, despite its recent slowdown. But you need to keep in mind that many risk factors come with investing directly in Chinese stocks.

One of the biggest risks is politics. China’s periodic leadership changes can bring positive or negative changes for foreign investors. China is still in the early stages of establishing the rule of law, in which property rights are respected. Corporate governance is in its infancy, and control of corruption is sporadic.

ADRs on Chinese companies offer some benefits over stocks that trade in China. Chinese companies that want to maintain their ADRs have to follow some U.S. Securities and Exchange Commission and New York Stock Exchange rules.

In the most recent Inner Circle Q&A, Pat looks at possible political unrest in China and whether changes in the legal and political climate would work to the benefit of foreign investors. He also considers the extent to which 7 Days counters political risk with its status as an ADR. He concludes with his clear buy-hold-sell advice on this stock.

(Note: If you are a current member of the Inner Circle, please click here to view Pat’s recommendation. Be sure to log in first.)

COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members

In the 1990s, there was a fixed idea that emerging markets like China were bound to pay off much better than North American equities. Later many decided that China and other emerging markets exposed investors to too much risk. What is your opinion on the wisdom of investing in the so-called emerging markets? Which ones do you like best and worst? Let us know what you think in the comments section below. Click here.