Are Chinese stocks now cheap?
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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Frequently Asked Questions about this Article…
Chinese stocks have fallen due to a significant drop in the Shanghai Composite Index, which has decreased by 31% over the last month. This decline is despite efforts by the Chinese Government to stabilize the market.
It might not be the best time to invest in Chinese stocks as the market could still have a long way to fall. The high price-earnings ratios suggest that the market was in a bubble, and the recent correction may not be enough to offer value.
The median trailing and forward price-earnings ratios for Chinese stocks are currently 50 and 34 times, respectively. These high multiples indicate that the market was significantly overvalued.
Chinese stocks have much higher price-earnings ratios compared to Australian stocks, which trade on a trailing and forward PER of 16 and 15 times, respectively. This highlights the overvaluation in the Chinese market.
The World Bank predicts that China's GDP growth will slow year on year, with an expected growth rate of 6.9% in 2017. This is lower than the previously predicted 8% by many analysts.
The Chinese stock market might continue to decline because companies cannot grow at rates higher than the economic output of the country indefinitely. As China's economy slows, the stock market is likely to adjust accordingly.
Investing in Chinese stocks right now carries the risk of further declines, as the market may still be adjusting from a bubble-like state. The high valuations suggest that there is little value even after the recent correction.
You can get more insights, stock research, and BUY recommendations by taking a 15-day free trial of Intelligent Investor.
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