China’s policy makers clearly recognize that “becoming a world factory” is not a sustainable strategy for the country in the longer run.

The government is now making its strongest efforts ever to promote homegrown technologies and innovation capability of domestic firms, including by introducing major tax incentives from 2H this year.

Key sectors that will enjoy robust demand growth and government supportinclude advanced manufacturing, telecom equipment, IT, alternativeenergies, new materials, environmental treatment, pharmaceuticals andmedical equipment.

We identified 11 companies that are among the most innovative within theirrespective sectors and that will enjoy sector specific catalysts, benefit from government support for innovation, and are less vulnerable to monetary tightening.

Valuation wise, this “China innovation portfolio” is trading at 20X of FY06 earnings, while their FY06-07 EPS growth is expected to reach 36% per annum.