China stock market

Traders favour Chinese small-cap shares as valuation premiums vault

The small-cap ChiNext Index has risen 5.9 per cent so far in 2018

PUBLISHED : Wednesday, 09 May, 2018, 7:41pm
UPDATED : Wednesday, 09 May, 2018, 10:15pm

Shares in China’s smaller companies are performing better that their larger peers, after delivering more solid earnings growth, particularly those involved in innovation and core technologies – key priority sectors of the Beijing government, particularly as the trade stand-off with the US continues unresolved.

The gap in the relative valuation between two of mainland China’s share gauges – the ChiNext index of start-up firms and large-cap CSI 300 Index – has risen to its highest level in two years, based on price to earnings (PE) ratio, according to latest data compiled by Bloomberg.

Companies on the small-caps index traded at 26.2 times estimated earnings, compared with a five-year average of 37.7 times, the Bloomberg data shows.

The increased interest in ChiNext means it has risen 5.9 per cent so far in 2018, compared with a 4 per cent fall by larger company peers listed on the CSI 300 Index.

Chart of the day: The roar of China’s ChiNext

ChiNext is targeted at attracting innovative and fast-growing firms, especially hi-tech companies.

Smaller companies are strongly back in favour with investors after enduring a two-year decline that made valuations almost a third cheaper than their five-year average.

Adding further momentum to the appeal of small-caps is the lingering presence of potential a trade war against the US, after Washington threatened US$150 billion worth of tariffs, and it barred sales of crucial technology to Shenzhen telecoms equipment maker ZTE.

ChiNext’s cheaper valuations against big-caps may extend the small-cap gauge’s rally

Chinese President Xi Jinping has recently stressed the urgency and significance of developing and owning key domestically produced technology.

“With the escalation in trade friction between China and the US, the urgency of developing innovative technology has become the top priority,” said Wang Jianhui, an analyst at Capital Securities.

“It’s expected that more related policies will gradually be implemented going forward, and that their importance will continue to be ramped up.”

Chip makers, electronics, and cloud computing stocks have been receiving the steadiest fund inflows among smaller companies, on the optimism of that ongoing government policy support.

An uptick in earnings growth is also fuelling the rally, as smaller companies are more reliant on organic growth to boost profits, than on the mergers and acquisitions.

With the escalation in trade friction between China and the US, the urgency of developing innovative technology has become the top priority
Wang Jianhui, an analyst at Capital Securities

According to Haitong Securities figures, ChiNext-traded companies posted a 29 per cent profit increase in the first quarter, recovering from a 16 per cent decline for the whole of 2017.

ChiNext board celebrates birthday as mainland start-ups clamour to list abroad

Another factor reducing the lustre of major companies compared with their smaller peers, is many are considered overvalued after being snapped up by bargain-hunters over the past year, with some blue-chips disappointing investors by not making any dividend payouts.

Mutual funds have also been seen to be pulling out of big companies during the first three months of the year, according to recent quarterly reports, with fund managers growing more concerned that profit growth will slow, and estimates will be missed.