Why Chinese stocks perform poorly
Joe Zhang says firms rely on favours from parent companies, officials to look good before a listing
China's equity market has been around for 20 years, and its performance has been very disappointing. Since its birth in 1994, the Hang Seng China Enterprises, the so-called H-share index, has gone up only 44 per cent, though the Chinese gross domestic product has grown almost tenfold in nominal terms. So why the huge discrepancy?
Having worked for years as a research analyst, I have some thoughts about this seemingly strange phenomenon.
First, a large number of listed Chinese companies cooked their books just before their initial public offerings, sometimes assisted by local governments. Of course, the fake elements could not grow indefinitely, unlike revenues or profits. This has led to a prolonged period of unnaturally slower growth and even a decline of net profits after their IPOs.
Just before they went public, some companies received "support" from parent companies or controlling shareholders. This came in many forms, such as parent firms taking over from the IPO companies a bloated workforce and/or expenses (even expenses related to the IPO), or through the purchasing of the products from the IPO companies at higher prices, and the selling of input (or raw materials) to the IPO companies at unfair prices.
Special assistance also included low-interest loans, and restructuring, such as the "supporters" taking over failing business units at sweetheart prices.
All these forms of assistance are one-off in nature and cannot grow the way revenues and profits grow
Local governments even mobilise their tax departments to assist IPO companies. They also give cheap land to these companies or allow them more lenient environmental standards. "Asset injections" are another form of assistance from controlling shareholders that fool minority investors, as these are neither organic nor sustainable. The list is long.