An Often Unmentioned Factor About Chinese Stocks

by: Oriental Trader September 07, 2008 | about stocks: CAF / FXI / PGJ    

Oriental Trader

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The Shanghai Stock Exchange Composite Index has fallen around 60% this year, the worst-perfoming major stock index in the world.

Many investors tend to use iShares FTSE/Xinhua China 25 Index (FXI) or PowerShares Golden Dragon Halter USX China (PGJ) as an ETF for Chinese stocks.

However, this is misleading.

FXI invests in H-shares or ADRs (which are usually H-shares as well). H-shares are stocks of mainland China companies that are traded on the Hong Kong Stock Exchange.

According to common sense, H-shares should trade at similar valuations to their corresponding shares on the mainland stock exchanges (Shanghai or Shenzhen).
Let's take a look at the holdings of FXI.

The largest holding: China Mobile (CHL).

According to Yahoo Finance, CHL has a P/E of 14.21 while the equivalent trades on the Shanghai stock exchange for a P/E of 19.1. A 34.4% premium.

PetroChina (PTR) has a P/E of 12.69 while the equivalent traded in Shanghai has a P/E of 22.6. A 78% premium.

Ping An [2318.HK] has a P/E of 19.1 in Hong Kong but a 21.6 P/E in Shanghai. A 13% premium.

China Life [2628.HK] has a P/E 19.26 Hong Kong but 31.2 in Shanghai. A 62% premium.

These stocks trade at high premiums to their respective H-shares in China.
However, China Merchants Bank, Industrial & Commercial Bank of China, and Bank of China trade at premiums in Hong Kong compared to Shanghai.
It is believed that H-shares are usually more fairly valued due to Hong Kong having more sophisticated investors than mainland China. Also, most of these stocks have few shares that are publicly traded despite a large market capitalization. For example, the Industrial & Commercial Bank of China has 334 billion shares but only 15 billion are floated. In the bull market between 2005 and 2007, many investors bought such stocks in a frenzy, causing supply and demand to be a bigger factor in the valuation of these shares than their actual value.

H-shares traded at a large discount to the equivalent shares in Shanghai during the big bull market in China in 2005-2007, and hence were more stable when the stock fell. For example, while PTR might have fallen 50% since the peak in October 2007, the equivalent traded in Shanghai has fallen 75% (and is still trading at a 78% premium to an equivalent share of PTR).

This is one factor I believe many investors are not aware of, as we assume that the market would arbitrage out such a discrepancy. However, due to restrictions on selling short and perhaps just investor mania on the mainland, the discrepancy did not become smaller until the bear market this year.

It is hard to ascertain where the Chinese stock market will go from here, though it appears to be a in a downtrend. This is just another factor for the reader to consider.

Also, you won't confuse FXI with mainland Chinese shares any longer. If you seek an ETF that invests directly in mainland Chinese shares, Morgan Stanley China A Share Fund (CAF) may be a better option.

Stock position: None.

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This article has 8 comments:

  •  
    Sep 07 11:56 AM
    Please be aware however that the Chinese Government and large companies like Ping An have got the ability to arbitrage between the Shanghai and Hong Kong markets. And are doing so.


    Reply | Link to Comment
  •  
    Sep 07 07:21 PM
    And yet, if you overlay FXI and CAF, they look pretty much the same on a daily, weekly and monthly basis anyway.. jegan
    Reply | Link to Comment
  •  
    Sep 08 08:17 AM
    Yes, H and A -shares demonstrated high correlation.
    After my long time analysis I would suggest 50% in A and 50% in H.
    The simplest way is HSBC Dragon Fund ETF 0820:HK

    For those interested, here is my very old blog article:
    www.letsthinkchina.com...
    Reply | Link to Comment
  •  
    Sep 08 10:40 AM
    Siwei, what is the rational of 50% in A and 50% in H?
    Reply | Link to Comment
  •  
    Sep 08 11:30 AM
    This is a simple mislabeling. No big deal.
    Reply | Link to Comment
  •  
    Sep 08 09:12 PM
    remember folks.you are investing in a communist dictatorship.the goal posts could be on wheels.its happened before.can it happen again?
    Reply | Link to Comment
  •  
    Sep 09 03:14 AM
    This article has several pieces of incorrect information:

    One cannot use Yahoo Finance PE ratio to determine the market premium between the A shares in mainland China and H shares in Hong Kong. The reason is that data from Yahoo Finance is not always accurate!

    For example China Life yesterday closed at RMB$24.02 in China and
    at HK$29.50 in Hong Kong. After adjusting for currency China Life is only trading at 92.3% in China vs in Hong Kong.

    For example PetroChina yesterday closed at RMB$11.36 in China versus HK$9.65 in Hong Kong. After adjusting difference in currency the premium of PetroChina is 34.3% in China, not 78% as the author claimed.

    Yesterday the Hang Seng AH premium index stood at 106.49 which means the A shares as presented by the 50 stocks in the index is 6.5%
    more expensive than its H share siblings.

    Finally I like to point out that China Mobile is listed in Hong Kong and not in China which makes the comparison between its A share and H share valuation moot.

    You can review the datat Hong Kong Hang Seng Bank:

    www.hsi.com.cn/hsicn/e...
    Reply | Link to Comment
  •  
    Sep 10 12:10 AM
    I own both in a 3 to 4 ratio (1500 FXI & 2000 CAF) and have watched both drop from the mid $70's to $28 on CAF and $37 [split adjusted] on FXI. I also own TWN /Taiwan Fund for a 'complete' China investment. I call them my China 'T' shares and they are doing poorly also. For info there are A, B, & H shares for mainland China / A, B & Hong Kong / H.
    Reply | Link to Comment
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