China stock market

China’s ChiNext stocks are cheap, but not enough to buy

Although the ChiNext board is heading for a second year of losses and stocks prices have fallen below 2015 market crash levels, investors say they are still overvalued

PUBLISHED : Tuesday, 09 May, 2017, 5:19pm
UPDATED : Tuesday, 09 May, 2017, 10:56pm

China’s small-cap stocks are now cheaper than they were in the 2015 market crash.

Shenzhen’s ChiNext index of small firms dropped 1 per cent to an intraday low of 1,770.59 on Tuesday morning trading.

The level was 8.6 points below the nadir seen on September 2, 2015 amid the mayhem that erased US$5 trillion in market value. Even after more than halving from its peak, ChiNext stocks are still far from being bargains now because of stretched valuations and slowing earnings growth, according to investors including Xufunds Investment Management.

“There’s a lot of doubt about the true growth of ChiNext companies and we haven’t seen any company on it turning into a true growth one,’’ said Wang Chen, a partner with the Shanghai-based fund management firm. “The valuations don’t match the growth rate. The market is still in the long process of finding its bottom.”

The ChiNext board is heading for a second year of annual losses. Its gauge rebounded in the afternoon session to close 0.8 per cent higher to 1,802.49 on Tuesday, trimming its decline to 8.1 per cent this year. It is lagging the Shanghai Composite Index of mainly larger companies, which has so far slipped 0.7 per cent in 2017.

There’s a lot of doubt about the true growth of ChiNext companies and we haven’t seen any company on it turning into a true growth one
Wang Chen, Xufunds Investment Management

Yet, the ChiNext companies are still more than three times as expensive as those on the 1,268-member Shanghai Composite. The small-cap gauge is valued at 51 times earnings, compared with the multiple of 16 times for the Shanghai index.

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Drying liquidity spurred by the government’s accelerated efforts to clean up the financial industry has taken its toll on Chinese small-cap stocks. Speculators are fleeing equities amid increased scrutiny of manipulations, and banks are required to pull out money from wealth management products that illegally invest in stocks and bonds.

Guangdong Wens Foodstuff Group, the most valuable company on the ChiNext index, has slid 19 per cent this year on falling pork prices. Another heavy-weight, Leshi Internet Information and Technology, which is mired in cash crunch because of over-investment, has fallen 14 per cent.

The ChiNext market, in which 636 firms are traded and created in 2009 to make financing easier for start-up companies, endured the biggest stock bubble in China’s history. The index jumped by more than three-fold within a year through June 2015, sending the valuations to more than 100 times earnings, as the central bank cut interest rates and policy makers initiated “mass entrepreneurship”.

The bubble quickly burst, with the gauge shedding 56 per cent from the peak in the ensuing three months, after securities regulator banned margin financing that was illegally funded by non-brokerage institutions. Despite a subsequent short rebound, the market has been in the doldrums since.

Chinese mutual funds continued to pare their holdings in ChiNext companies in the first quarter of 2017, shifting to big companies with more secured earnings outlook. First-quarter earnings for ChiNext stocks do not point to an immediate reversal of their stock performances.

Earnings growth weakened to 25 per cent in the first three months from 34 per cent for the whole of 2016, as tighter regulatory approvals forced the companies to scale back buyout activities, a major source of earnings increases over the past years, according to GF Securities. The Guangzhou-based brokerage expects growth to further slow to 19 per cent this year.