Chinese companies’ stock price dropped sharply in the recent months, which seems to be an opportunity for entry. Should people take it?
We need to address a few questions.
Why the drop?
On the surface, China’s economy is entering a slow/no growth mode, with a deteriorating global business environment (especially towards China).
More recently, the sell-off accelerated as many retail investors were “forced” to deleverage. It’s not obvious, but on the personal finance level:
1) home prices declines triggered deleverage, where most Chinese families store most of their wealth. Especially for those who had taken out home equity in the forms of loans when housing prices were peaking in 2021, refinancing at similar level is nearly impossible now. To fill the gap, they need to sell other assets, or to give up the house for auction. Those who had bought stocks using the home equity are likely to suffer big losses in this process.
2) many high-yield investment products have stopped functioning, which may indicate potential meaningful loss in income and principle (those products are likely to have links to real estate developers or equity markets). If people were dependent on those investment products, it’s could cause troubles in personal finance which leads to deleverage.
Therefore, the buying power directly or indirectly built upon people’s home loans or purchases of investment products is liquidating.
Why bother to buy?
1/ Their are still unique companies / business models / edges that’s hard to find elsewhere.
e.g. CATL is still the most efficient and large-scale battery producer, with profits. There are geopolitical concerns but CATL is also building capacities overseas. If the edge in production over others can sustain, and it can grow overseas in a way that local authorities endorse, it looks to be an investable business.
More specifically, the criteria I would argue is that its products or services are incrementally positive to the global economy, or is unique on the global stage, not just among Chinese peers.
In another word, some companies are still a valuable part of global economy, so investors don’t necessarily need to be interested in China, and may choose to hedge some beta/macro risk.
2/ Valuation has come close to global standard.
When you can easily get a 4%+ risk-free rate in savings, it requires a much higher rate for Chinese equities to be attractive.
Depending on risk appetite, 15x p/e implies 6.7% earnings yield, and 12x implies 8.3% earnings yield.
E.g. CATL is around 15x LTM p/e, although we need to see if it’s sustainable as battery prices dropped pretty dramatically. The point is if it’s a normalized 15x p/e for a globally unique business and is growing, it does offer some value to a portfolio.
