Are Chinese stocks now cheap?

With the recent sell-off in Shanghai, have Chinese stocks finally come back down to earth or is there still a way to fall? Despite the best efforts of the Chinese Government, the Shanghai Composite Index has fallen 31% over the last month. Such a drop in such a small time leads to the obvious question – is now a good time to invest in Chinese stocks?

Despite the best efforts of the Chinese Government, the Shanghai Composite Index has fallen 31% over the last month.

Such a drop in such a small time leads to the obvious question – is now a good time to invest in Chinese stocks?

The answer is almost certainly not. The Chinese market still might have a long way to fall.

New trading accounts have skyrocketed in the past year as Chinese mums and dads embrace the stock market, many considering it to be the best casino outside of Macau. In fact, in April there was over 4 million new trading accounts opened in a single week.

The median trailing and forward price-earnings ratio of Chinese stocks are 50 and 34 times respectively. The fact that even after a correction of more than 30% the price-earnings multiples are still astronomically high shows just how bubble-like the Chinese market was to begin with.

To put this in context, currently Australian stocks currently trade on a trailing and forward PER of 16 and 15 times.

The argument from many China bulls would be the growth potential of the country justifies a higher rating. But Australia is a poor comparison due to its mature and developed economy.

China has done a great job in industrialising in recent decades but the World Bank predicts the rate of GDP growth to slow year on year with expected GDP growth in 2017 of 6.9%.  At one stage many analysts predicted 8% for that year.

Companies cannot keep growing at higher rates than the economic output of the country they operate in forever. With an economy that is slowing down it is only natural that the stock market adjusts to that fact. Unfortunately for the Chinese government, it is not a rule that stock prices must forever continue upwards.

There is little to suggest that even at current valuations that the Chinese market offers value. If I were in China, I would not be ready to put my home as collateral for a margin loan just yet. This drop may just be the beginning

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