{"id":8333,"date":"2024-02-09T09:57:47","date_gmt":"2024-02-09T08:57:47","guid":{"rendered":"https:\/\/hqam.ch\/?p=8333"},"modified":"2024-02-09T10:27:44","modified_gmt":"2024-02-09T09:27:44","slug":"how-attractive-are-chinese-equities","status":"publish","type":"post","link":"https:\/\/hqam.ch\/en\/how-attractive-are-chinese-equities\/","title":{"rendered":"How attractive are Chinese equities?"},"content":{"rendered":"\t\t
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GDP growth vs Equity market growth <\/strong><\/p>\n

The Chinese \u2018tiger\u2019 has always attracted attention and grabbed investor\u2019s attention. China is leading global tops in terms economic growth surpassing European and US economies. However, does the real economy translate into the returns for equity investors? And does the growth in the real economy follow the growth we witness as shareholders of the Chinese companies? <\/p>\n

In fact, there is a significant disparity between the growth of the economy and the development of the stock market. The Chinese economy was booming, in contrast to the stock market, which made close to zero returns. In comparison, the US economy was growing at much more moderate pace than China, but the US stock market was adept at generating returns (fig. 1). <\/p>\n

Figure 1: MSCI regional indices since 2010 in local currency annual return:<\/em> MSCI China 1.9%, MSCI USA 10.7%, MSCI Europe 3.4%<\/em><\/p>\n\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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Source: H\u00e9rens Quality AM, Reuters<\/figcaption>\n\t\t\t\t\t\t\t\t\t\t<\/figure>\n\t\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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One should understand that the stock market is not a representation of the country\u2019s economy. The stock market represents the listed companies, which might have global operations and therefore having exposures to regional economies. However, given that the headquarters are located in a certain country, the company is exposed to political and regulatory risk, which might have substantial impact on the company\u2019s performance. Furthermore, the responsible management culture is essential, as successful investing hinges on fostering trust among all involved parties. <\/p>\n

Does valuation matter? <\/strong><\/p>\n

Note that Chinese equities have almost always been traded at a discount compared to US and European stocks (Fig.2). Low valuation does not always mean it is a good bargain as we have described here: ( https:\/\/hqam.ch\/en\/how-fair-is-fair-valuation\/ <\/a>). If the share price of the company drops substantially, it does not always mean that this is the point to jump in. There is always a possibility for the stock to continue its decline. <\/p>\n

Figure 2: Median forward PE of MSCI regional indices<\/em><\/p>\n\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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Source: H\u00e9rens Quality AM, Reuters<\/figcaption>\n\t\t\t\t\t\t\t\t\t\t<\/figure>\n\t\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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The lower valuations of Chinese companies are frequently attributed to political risk and heightened degree of policy uncertainty (Yang, et al.,2019). Concerns escalating issues in the real estate sector, which accounts for 30% of China\u2019s GDP, have also exerted downward pressure on the valuations and performance of Chinese equities. State-driven demand often leads to economic imbalances. And the real estate stands as a prominent illustration of regular state interference. More than half of China\u2019s former 50 developers including flagship companies like Evergrande and Country Garden, have defaulted. <\/p>\n

How fundamentally good are Chinese companies?<\/strong><\/p>\n

You would be surprised but the quantitative financial assessment of Chinese firms beats all expectations as seen in Fig 3, showcasing the results of our global corporate excellence award evaluation. In the global stock index MSCI World AC emerging markets part, where the vast majority is represented by Chinese companies, accounts for 49%. Contrasting this with the breakdown by regions within the best 100 companies according to financial quality, emerging markets hold 65% share of the global top quality universe. <\/p>\n

Figure 3:<\/em> MSCI All Country World Index Distribution \/ Global Top 100 Quality Companies<\/em> <\/p>\n\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t

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Source: H\u00e9rens Quality AM, Reuters<\/figcaption>\n\t\t\t\t\t\t\t\t\t\t<\/figure>\n\t\t\t\t\t\t\t\t\t<\/div>\n\t\t\t\t<\/div>\n\t\t\t\t
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Financial health of the Chinese universe surpasses that of its global corporate peers. Capital returns are at high level, while debt levels are enviably low. <\/p>\n

Qualitative Analysis as major value-adding element <\/strong><\/p>\n

While financial figures and traditional ratios of Chinese companies seem impressive, it is crucial to carefully consider all aspects of the business model and the competitiveness of firms. There have been multiple cases of \u2018creative accounting\u2019 among Chinese companies, which led to huge losses in investment portfolios. Insufficient control from watchdogs and weak corporate governance control lead to cooking books cases: inflated profits, understated leverage, boosted receivables. <\/p>\n

To detect possible fraud, qualitative analysis is extremely important, especially when investing in emerging markets, which are usually undercovered. These markets often lack scrutiny from market participants and have a limited number of analysts. <\/p>\n

A notice to investors \u2013 main takeaways<\/strong><\/p>\n