The week explained: cheap Hong Kong equities
Sometimes Hong Kong investors are all too aware of the negatives and can't believe good news when they see it. However, whichever way you look at it, shares on the local bourse are pretty cheap. They are arguably among the best bargains in the world right now. Recently, the Hang Seng Index's average price to earnings ratio (PER) slipped below double digits, leaving the market trading on an average PER of some nine times. And this is accompanied by average yields of about 3.5 per cent.
In other words, the value of earnings compared to the share price is modest and the level of yield exceeds that available on most fixed-interest instruments. The Hong Kong market has historically traded on lower PER ratings than other major markets, but it is rare to see ratios at this level.
Price/earnings are share price divided by earnings per share. It is the most commonly used measure to standardise, and therefore compare, share prices.
Compare Hong Kong with the United States market, for example, which is trading on a PER of about 15 times, yielding a modest average of about 2 per cent. Even Britain's battered market is trading on a PER of some 12 times, but with a slightly better average yield of some 3.5 per cent. Japanese shares have never really been "cheap" by these measures and today, with an average PER of just below 14 times and an average yield of 2.5 per cent, they remain as unattractive as they have been for a very long period.
Meanwhile, over in the world of so-called developing markets, where risks should be higher and rewards are said to be commensurate, share-price ratios make Hong Kong look even better. Look at what's happening in the markets of the BRICS high-growth economies. India is on an average PER of almost 17 times, Brazil is less demanding with an average PER hovering around 12, and the South African market is trading on an average PER of more than 14 times.
Only Russia is truly cheap in this group, trading on a PER below six times, yielding almost 4 per cent. But this is a market reserved for the brave.
And in the Chinese market, often regarded as the turbo engine of the BRICS group, valuations are rather more modest. Gone are the days when Chinese equities traded on truly mind-blowing PERs of about 50 times. The Shanghai B-share market is on an average PER of some 11 times, while the less-traded Shenzhen B market is on an average of about nine times.
But what does the future hold for Chinese stocks when valuations are comparatively low? Most analysts are cautiously bullish over the prospects for its economic growth. If this is the case, why do Chinese share prices remain so stubbornly in the doldrums? China is one of the worst performing major markets in the past 12 months, with prices down 17 per cent.
Those who are sceptical about China's growth prospects realise why investors are staying away but still find value in Chinese stocks, if of an opportunistic, short-term nature.
A year ago, the average PER on US shares was 12. It is now around 15, up 25 per cent - almost exactly the level of gains in share prices during this period.
Here in Hong Kong, we have a very liquid market, governed by the kind of regulations that give comfort to international investors. Many local companies have strong balance sheets and we do business in a currency pegged to the gravity-defying US dollar. Yet share prices, and PERs, have languished.
So don't ignore value when it lands on your doorstep.