FYI | May 30 2007
One of the things that irritated me enormously ever since I started writing my first financial news stories, now more than a decade ago, is that journalists are not considered to be particularly smart.
Not by the CEOs whom we interview on occasion, and certainly not by securities analysts who are trained to know the dynamics of a certain company and its sector from left to right and from the bottom to the top.
All jokes and past anecdotes aside, I can only acknowledge at various times that “we” –those journalists- do an awfully good job in confirming this stigma.
The latest example concerns the Chinese stock market, a subject that will, no doubt, fill many news columns and analyses in the days ahead now that Chinese investors have come up with a knee-jerk response to the increase in local stamp duty tax to 0.3%.
From Li Ka Shing to Alan Greenspan to nearly every self-respecting commentator around, everybody has been warning about how Chinese investors, like lemmings, are pushing their savings (and loans) into an ever increasing stock market. Up 50% for the year! The number grows even more astronomical when we take early 2006 as the starting point.
I am not disputing the mania-alike features that have accompanied the resurgence of the Chinese stock market, I do question the misinformation that accompanies these warnings. Chinese shares are trading at price earnings ratios of more than 50. How many times have I read this “fact”?
Alas, look deeper into the matter and what you’ll find is that this oft cited gigantic PE figure –the symbol of the Chinese stock market craze- is little more than a blunt misrepresentation of what is actually occurring in the land of 1.3bn world citizens.
Investing is a forward looking exercise so why would anyone look at last year’s profit figures other than to try to inflate an argument that already looks valid on the basis of other, more accurate data and numbers? It has me stunned. It stuns me even more to see that some highly respected market specialists have started to cite the “fact” as well.
It raises the question who the real lemmings are in this story.
In case you hadn’t figured it out by now everyone who calls the Chinese share market at a PE ratio of 50 is referring to last year’s profit figures. To illustrate just how misleading such a methodology is, I’ll use one of the fast growing stocks on the local bourse in Australia as an example: emitch (EMI), soon to be renamed as Mitchell Communication Group.
On last year’s reported EPS figure of 1.4c emitch shares, which closed at $1.25 today, are trading at a PE ratio of 89. Now that’s a bubble! So do we Sell?
Let’s consider this year’s EPS estimate first. Emitch is expected to report a net profit per share of 4c for the current fiscal year. This is expected to grow to 6c in FY08. On this basis the stock’s PE ratio is 31 and less than 21 respectively. Still expensive but these are the kind of multiples investors are willing to pay for a company which is growing significantly above market speed.
As a comparison, CSL (CSL) one of the high flyers amongst the local large caps, is trading at a FY07 PE of 31 and a FY08 PE of 26. On last year’s figure, however, CSL’s PE blows out to 47.
This is why CSL is rated 0.6 on the FNArena Sentiment Indicator (6 buy recommendations plus one Accumulate) and emitch’s reading is 0.5 (one Buy and one Neutral rating).
You certainly won’t see me using the PE 50 figure.
Looking into this year’s profit estimates reveals quite a different picture, one of a Chinese share market that has been in the doldrums for five years providing investors with negative returns during a period that saw shares of BHP Billiton (BHP) triple in value.
Chinese shares are currently trading on a forward PE of 25 (FY07) and 20 (FY08). Admittedly, this is still well above what we’re used to in developed markets such as Australia where the market is currently on a FY07 PE of 17.5. Looking at prospects for FY08 the local PE stands at a little less than 16.
For the US the comparable figures are 17 and 15.
Bubble? Hardly.
Especially when one considers the Chinese stock market is going through some fundamental changes with Chinese companies transforming themselves from former low growth government controlled dormant utilities into fast growing expansionist modern cash cows.
This is probably best illustrated by the fact that profit growth estimates for Chinese listed companies is currently among the highest in the world. On figures provided by Thomson Financial, the average EPS growth estimate in China stands at 24.37% for this year and at 23.47% for FY08.
These figures compare with average EPS growth figures of 13.50% and 11.05% for Australia and of 9.29% and 13.64% for the US respectively.
One could argue that Chinese stocks deserve a premium because they’re offering significantly higher growth prospects, even if local accountancy practices and disclosure are still subject to some heavy criticism from outsiders.
This probably explains why Lin Yuan, the local Chinese stock market hero who is nowadays standard referred to as the Chinese Warren Buffett, declared this week he is not selling any of his shares.
Now 44 years of age, Yuan managed to turn an initial stake of 8,000 yuan into a portfolio worth well over one billion yuan over the past 18 years. He is the iconic example that drives thousands of new aspirant billionaires into the Chinese stock market every day.
Again, all those figures oft cited about the significant amounts of new trading accounts that are being opened every day in China seem scary at first, but once we put them in the context of a population of 1.3bn Chinamen…
All this doesn’t mean that everything that is happening in China is beautiful, normal and perfect, but it certainly puts a different perspective on things.
As it happens, market strategists at BCA Research issued a report this week which broadly confirmed the view that there appears to be no reason for a significant pullback in Chinese stock prices.
In a market update which I thought was disappointingly titled “China’s Equity Bubble: Likely To Inflate Further” BCA stated that “The Chinese economy still provides a fertile ground for manias in stocks: Good economic growth, soaring profits, low inflation, a strong currency and exceedingly low interest rate. Those factors, together with high past returns constitute a perfect magnet for small investors and in turn will fan the flame of speculation.”
BCA argued, a point I will not dispute, that investors looking to play the China theme better focus on the Hong Kong share market. Thomson Financial figures show shares in Hong Kong are trading on average PEs of 15 for both FY07 and FY08.
Having said all this, the Chinese stock market did take a considerable loss on the first day following the announcement of an increase in the stamp duty tax to 0.03% from 0.01%, and the whole wide world was closely watching the event.
Maybe the big news from Tuesday night’s announcement by the Chinese authorities was that the Chinese government seems to have moved away from attempting to cool the domestic share market through market friendly deregulatory measures and is resorting instead to taxation and increases in regulation, which are by nature “less-friendly” actions. A point brought forward by the outside the box thinkers at GaveKal on Wednesday.
China’s FY07 PE of 25+ is the highest in the world (52 markets surveyed by Thomson Financial) clearly beating some lesser-known minnows such as Croatia (24.90), Morocco (20) and Slovenia (20).
But maybe investors should pay more attention to the gradually higher creeping yields on US Treasuries that are currently supporting the bounce back of the US dollar.
China’s growth prospects, by the way, are still beaten by the likes of Argentina (242%), Austria (34%) and Finland (40%), among others.
Till next week!
Your always happy to share my insights editor,
Rudi Filapek-Vandyck
(as always firmly supported by the Fab Three: Chris, Greg and Terry)
