Despite stellar gains, analysts say stocks are not overpriced Investors who bought into the H-share index a year ago have more than doubled their money, making it a reasonable enough time to cash in. However, the good news keeps coming, and according to analysts watching mainland developments there should still be more life in the index, which tracks Chinese enterprises listed in Hong Kong. They caution investors will need to choose carefully. 'At this stage, obviously you have got to be relatively selective. I think they are getting quite pricy,' said Michelle Mak, head of China research at ABN Amro. 'We actually have been telling people to underweight [China] on a regional basis, but we are still advising our clients to buy ports as this is one area that is enjoying strong domestic growth.' The share price gains have been driven by a combination of improving economic growth and corporate earnings as well as lots of liquidity in the market. More recently, stronger commodity prices and speculation on an appreciation of the yuan have added to the buying appetite. Yesterday, the sector was given another shot in the arm when Moody's Investors Service upgraded China's foreign currency rating, citing further economic reform and financial and capital account liberalisation. The H-share index gained 2.64 per cent in response, bringing the 12-month gain to 104 per cent, while the blue-chip Hang Seng Index (HSI) fell 0.24 per cent. The HSI has significantly lagged the H-share index over the past 12 months, despite a healthy 27 per cent gain. Although the rally has led to the H-share index being priced at about 15 times earnings, compared to only eight times at the end of last year, not everyone agrees that the valuations are too high. According to Bloomberg data, the HSI is trading at a price to earnings multiple of 18.4 times, while the Dow Jones Industrial Average is at 20.9 times and the Shanghai A-share index is trading at 35.2 times earnings. 'Valuations are still not extreme, and many foreigners are still only warming up to buy them,' said Kingston Lee, head of Hong Kong and China research at ING Financial Markets. But a further re-rating of earnings multiples is not a necessity for more share price gains. Companies are becoming more transparent with regard to their earnings; consequently, investors have more confidence in the numbers they report. As profits went up and earnings outlooks were being upgraded, investors should also be prepared to push share prices higher, said Li Hui, head of China research at CLSA. Continued earnings growth was the key to further share price gains, which is turn hinged on companies being able to deliver more productivity gains and cost savings, Ms Li said. She remains positive on both counts, given that companies are restructuring not only their output and management, but also their distribution and raw-material procurement channels. Analysts are also expecting more money to flow into H shares under the qualified domestic institutional investor scheme, which will allow mainland investors to buy Hong Kong shares. Such money, they argue, would most likely find its way into H-share companies which are already well-known on the mainland through big brands such as Sinopec and China Merchants. While the scheme is unlikely to be implemented in the short term, it will remain a long-term positive for the sector, analysts say. In the nearer term, expectations of a stronger yuan and talk that economic growth in China may jump to about 10 per cent this year - far outpacing official forecasts of 8 per cent - will provide a powerful spur for investment. Until there were more investment alternatives for foreigners, H shares - which have most of their operations in China - would remain the single best opportunity to take advantage of this growth story, Ms Li said. On a sector basis, analysts generally like firms active in the domestic market, where they envisage a pick-up in demand. Utilities, infrastructure, cyclicals such as construction materials, and vehicle firms are not on the wish list.