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Toh Han Shih

Small cap stocks in Hong Kong and in mainland China are in a perilous bubble, making them vulnerable to a sharp correction that would put punters in a hole at a time when the country is struggling with huge debts and a softening economy.
“There are a lot of worries as to what happens to the China and Hong Kong markets, in the event of a repeat of the 2007 bubble and whether it will end in tears again,” Credit Suisse analyst Vincent Chan said in a report.
“The bad news is that P/Es (price-earnings ratio) of small caps in China, represented by the Shenzhen SME (small and medium enterprise) and ChiNext market, are at bubble valuations. At some point, there will be a massive correction of these stocks. Avoid this space!!!” warned Chan.
The Shenzhen stock market has more small-cap stocks than the Shanghai stock market, which is populated by large state-owned enterprises (SOEs).
Shenzhen remains overvalued despite the sell-off last Thursday when it slid 5.5 per cent.
On the simple price/earnings ratio (P/E) metric used by most analysts, the average P/E of Shenzhen A-shares has surged to 61.33 times on May 28 from 39.86 times on February 28. The average P/E of the GEM (Growth Enterprise Market) has grown nearly eightfold to 88.32 times on May 28 from 11.96 times three months ago on February 28.
In comparison, the average P/E of the main board of the Hong Kong Stock Exchange and Shanghai A-shares were at 12.42 times and 21.95 times on May 28 respectively.
Chan pointed out that in December 2007 during the last bubble, the P/E of the Hang Seng Index and the Shanghai Composite Index were at 21.1 times and 59.2 times respectively.
Most analysts would prefer a P/E of 15 to 20 and consider the valuation of stocks stretched and due for a pullback if the figures run too high.
But a Bank of America Merrill Lynch (BOAML) report argued that with China’s huge and rising corporate debt, the use of P/E is “meaningless” and a more appropriate measure of valuation is the Enterprise Value (EV) to Earnings before interest, tax, depreciation and amortization (EBITDA).
EV measures the value of a company based not only on its market capitalisation but also debt, minority interest and preferred shares.
China’s corporate debt has nearly tripled to US$12.5 trillion from US$3.4 trillion in 2007 and now accounts for 125 per cent of China’s GDP, up from 72 per cent in 2007, BOAML pointed out.
The median EV/EBITDA ratio of China’s A-shares is 27.0, the highest in the world compared to 10.6 for Hong Kong and 12.3 for the US, BOAML said. The median EV/EBITDA ratio of A-shares is 4.6 times China’s GDP growth, whereas that number was 1.4 times at the peak of the last bull market in October 2007, BOAML noted.
“Chinese A-share valuations have come unhinged from monetary conditions, nominal earnings and economic growth,” Merrill said. “Investors in A-share equities are being asked to pay the world’s highest EV/EBITDA multiples among the world’s lowest debt-adjusted ROEs (return on equity).”
 


Small cap stocks in China’s Shenzhen market in bubble territory, risking crash

An elderly Chinese investor rubs his forehead underneath an electronic board showing stock prices. Analysts fret that small cap stocks in Hong Kong and on the mainland are in bubble territory. Photo: Xinhua

Business

Markets

“There are a lot of worries as to what happens to the China and Hong Kong markets, in the event of a repeat of the 2007 bubble and whether it will end in tears again” - Credit Suisse analyst Vincent Chan


Expresses the views, ideas and conclusions of the author. (Eg. Enough of Crazy Rich Asians, think of crazy poor Hongkongers.)


Column

Portfolio

Portfolio | Small cap stocks in China’s Shenzhen market in bubble territory, risking crash

“There are a lot of worries as to what happens to the China and Hong Kong markets, in the event of a repeat of the 2007 bubble and whether it will end in tears again” - Credit Suisse analyst Vincent Chan