As the Chinese economy continues its transition from complete central state control to one that tolerates some level of private enterprise, the country has been minting millionaires. China now ranks third in countries with the most millionaires, behind the United States and Japan.

According to data from the Boston Consulting Group, 1.1 million Chinese households have a net worth of more than CNY10 million and nearly 400 households have a net worth in excess of CNY100 million. And those are just the ones that are known. Sinologists believe that for every known millionaire, there are probably two more flying under the radar for privacy reasons or tax concerns.

Granted, the pace at which Chinese millionaires are created has slowed. In 2011, nearly 90,000 new millionaires emerged—about a 10 percent year-over-year increase—while just 30,000 were created last year for less than 3 percent year-over-year growth (see chart below).



The slowdown in the Chinese economy obviously had a lot to do with that, as did a sharp decline in real estate prices in 2012. The latest Hurun Report from Group M shows that about 15 percent of Chinese millionaires earn their fortunes speculating in real estate. Their jobs have become much harder over the past two years, with real estate prices off by as much as 25 percent in some Chinese provinces.

But while the growth in newly affluent Chinese households is slowing in percentage terms, when it comes to the absolute number of new millionaires China is still the fastest grower in the world.

As with the wealthy anywhere else in the world, the rich in China are getting richer because they don’t just stuff their newfound wealth in the mattress.

Just as the Chinese government has been gradually loosening the reins on the market, it has also been implementing groundbreaking reforms in the country’s financial sector. The central bank has begun liberalizing lending rate policies, allowing banks to make their own decisions on the interest rates charged to different types of borrowers. Different sorts of lenders are also being allowed to enter the markets, ensuring that wealth management products such as trusts, mutual funds and other tools become more common under looser restrictions.

That’s giving rise to financial product firms catering to the wealthy, something that’s extremely common in the Western world but only just emerging in the developing markets. These firms are offering money fund accounts, mutual funds, real estate and private equity investment opportunities, as well as insurance products.

One of the leaders in that space is Noah Holdings Limited (NYSE: NOAH).

Founded in 2005, Noah has grown from one office to 57 today, located primarily in China’s more affluent coastal provinces. Since its inception, Noah has sold RMB74.2 billion worth of wealth management products as of the end of last year and currently serves 42,000 high net worth individuals in China with investable assets of at least CNY10 million.

Noah’s business model has proven so successful that in 2007, American venture capital outfit Sequoia Capital made a substantial investment in the firm.

As with most other financial services firms, Noah’s revenues are largely generated from one-time commissions on product sales and recurring service fees for managing client accounts.

In the second quarter of 2013, Noah’s net revenues shot up more than 132 percent year-over-year to USD44.3 million. One-time commissions were up 122.8 percent to USD22.8 million, thanks to larger than usual transactions and higher average commission rates. Recurring revenues were up 133.6 percent to USD20.3 million, primarily due to the growing Chinese fascination with private equity funds held under Noah’s custody.

Operating margin also rose to 41.6 percent versus 37.7 percent in the same period last year, largely because of increasing economies of scale. As Noah’s assets continue to grow, net revenue growth has been offsetting operating costs and expenses to a greater extent.

Net income for the quarter came in at USD14.7 million, with net margin at 33.3 percent. Net income per American Depository Share rose from USD0.11 to USD0.26 year-over-year.

For the full year, management expects net income to come in between USD50 million and USD55 million, a year-over-year increase of between 86 percent and 105 percent. That’s largely in line with Wall Street estimates which look for USD0.84 of income per ADS this year and USD1.06 in 2014.

While Noah is currently trading at 32.6 times trailing earnings, it is actually at a discount on a forward looking basis, commanding a price-to-earnings (P/E) ratio of just 16.4. Its price-to-earnings-growth ratio also comes in at just 0.5, offering a substantial discount to expected future growth.

The valuation disconnect largely stems from lingering unease over a slowing Chinese economy, though most metrics are now positive for the country.

It’s impossible for Chinese gross domestic product to continue growing at the blistering, low-double-digit pace of the past two decades, as the country’s economy matures. That’s particularly true as the Chinese economy evolves from an export orientation to one more dependent on domestic consumption.

Noah is an excellent play on that trend while, at the same time, offering a layer of protection against any slowdown thanks to the high net worth cliental it serves. Barring a complete meltdown in the domestic economy, Chinese millionaires will likely stick with their long-term investment plans despite any hiccups in economic performance.

At the same time, continued liberalization of the financial services sector will create more opportunities for Noah, particularly if the government begins allowing wealthy Chinese to invest in foreign equities as expected. Capital flight has been an ongoing concern for the Chinese government and it is beginning to take a “if you can’t beat them, join them” attitude towards the problem. By implementing regulatory steps to allow foreign investment, the government will be better able to track the pace of outflows while retaining a greater level of control.

That will create a huge opportunity for Noah Holdings to add another layer of products and services to its offerings, driving a faster pace of growth than currently anticipated.

The newest addition to our Long-Term Portfolio, Noah Holdings Limited rates a buy up to 21.