China discounts expanded again


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I picked up my twins from the summer camp in Vermont and returned after a few days of rest. The rain has been on them, but they still have a lot of fun. It is also raining heavily for investors in Chinese stocks, which is not fun, but it is interesting.

China discounts, part two

A generation wrote Regarding the China discount a few weeks ago. My conclusion at the time—following experts who knew China better than me—was incomplete at best.

After the regulatory actions against the taxi-hailing application Didi Chuxing-this is the most compelling and severe example of the crackdown on companies in the areas of technology, personal data and finance-it is clear that the Chinese authorities are giving absolute priority . Central control of data and financial stability. Companies and investors can pursue their own interests, but they are absolutely restricted by these priorities defined by the Chinese Communist Party.

In other words, from an investor’s point of view, the easiest part to understand. The difficult part is knowing exactly how Beijing defines control and stability, and how much discount it brings to Chinese stocks. There are discounts and it is growing, but it is difficult to determine.

In the past few days, we have received new information about the definition of CCP. For some investors, this is a Distressing learning process. The CCP has made it illegal to coach companies to make profits, raise funds, or go public abroad. The stock market value of Future Education Group, New Oriental Education Technology Group, and Gaotu Technology (all listed companies in the United States) suddenly shrank by two-thirds or more. They are all down 90% or more from their highs at the end of 2020.

This may have inspired some of the bleakest broker reviews I have ever seen. This is Goldman Sachs:

Influence: [sector’s] By 2025, the total potential market will shrink from USD 100 billion in 2020 to USD 24 billion. .. Profit from operating K-12 [tutoring] According to current contractual arrangements, the institution may no longer belong to shareholders. .. Our new 12-month price target is 78% lower than the previous average price.

In other words: the last one comes out, please turn off the lights.

The bigger news is that if the entire industry is not hollowed out, the property management company will feel it too. squeezeLast weekend, Chinese regulators issued a statement saying that they would “improve the order of the industry.” Stocks in this sector fell 15% or more on Monday. When the government expressed its determination to protect the rights of gig workers, the food delivery app Meituan’s share price fell 14%.

In my opinion, our tendency is that the CCP wants to control a wider range than we imagined: we must increase our strong (but vague) attention to social stability in addition to our attention to financial stability and the control of personal data.

Shuli Ren in conclusion Neatly in Bloomberg’s column (emphasis mine):

[The CCP is ] Control the power of its tech giants and Promote start-ups; Protect social equality; And ensure that the cost of living in the city will not be as high as the family Unwilling to have children … If you plan to invest in China, you must do so through its developing capital market. This will not only strengthen the domestic economy, but also allow Beijing to ensure that funds flow to the industries it wants to develop, and away from areas that it believes pose a threat to the public interest.

At this point, it may be worth breaking the notion that something like this has never happened in the United States.Some of you will remember that when President Barack Obama took over the for-profit university department in the United States, through “Paid employment”rule. It deprives those schools whose graduates have not found high-paying jobs to obtain government education loans. The department was hit hard.At least two listed companies (ITT Technical Institute and Corinthian Colleges) announced Bankruptcy . Now, you might think that many for-profit universities are just scams (I think they are). But the point is that the U.S. government can, and occasionally, everything else except the end of industry. The fraud of one government is the social “chaos” of another government.

As a result of the recent crackdown, are discounts in China increasing?International investors have Net salesAccording to the British “Financial Times” report, on Monday alone, the Chinese stock market fell by US$2 billion. An investor known for his risk appetite has seen enough.from Bloomberg:

Cathie Wood is exiting the Chinese stock market because Beijing’s suppression of private companies has sowed uncertainty across the market. .. According to the company’s trading activity data, the head of Ark Investment Management Company sold shares of technology giant Tencent Holdings Co., Ltd. and real estate website KE Holdings Inc every day last week. .. Her largest fund, ARK Innovation ETF, now invests only 0.32% of its $23 billion in assets in Chinese companies, up from 8% in February

How will this broadly affect the valuation of the Chinese stock market. China discounts are getting bigger and bigger? Of course, the relative price-to-earnings ratio valuation of the Chinese index lags behind the global index, but the trend is long-term and quite gradual:

To illustrate this point more clearly, the following is the mixed P/E ratio of the Mainland CSI 300 Index and the Hong Kong Hang Seng Index, divided by the MSCI global P/E ratio to estimate the China discount since 2005:

But this should not leave anyone with the impression that the Chinese market is experiencing a slow rout. In absolute terms, they did a great job. Consider the long-term chart of the CSI 300:

It is hard to imagine a party official looking at the chart and believing that the recent crackdown threatens to kill the golden goose of the capital market. The goose seems to be in good health.

In this case, it is useful to think about what might happen to the stocks with the least political or social impact in China. Do they trade at a price lower than their global counterparts? The best example I think of here is mobile telecommunications. Therefore, I analyzed the valuations of some telecom companies in developed countries, emerging markets and China:

Interestingly, on the basis of the P/E ratio, large Chinese telecom companies trade at a discount, but this is not common: China Telecom’s P/E ratio is the same as AT&T, and growth characteristics are roughly similar.

The biggest discount is enterprise value/Ebitda (for starters, this ratio is pre-tax profit, financing costs, and depreciation divided by equity value plus net debt-a ratio designed to eliminate abnormalities in the capital structure of different companies). I’m not entirely sure why China Telecom is so cheap on this indicator, I can only say that their leverage ratio is lower than that of their global peers, and their investment level is higher, and therefore depreciation.

In view of these differences, in my opinion, Chinese companies should trade at a higher price-to-earnings ratio. More investment should lead to greater long-term growth; lower leverage means financial flexibility (including the option of increasing returns through more leverage). But this raises another question: In the current environment, what are the political consequences of Chinese companies that decide to reduce investment or improve their balance sheets?

As far as I know, Chinese discounts apply even to this most common industry.

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