China’s Smaller Companies Slide on Valuations, Stock Supply

China’s smaller-company stocks slumped today on concern the expiration of restrictions on the sale of equities will lead to a jump in supply and that share- price gains have outpaced earnings growth.

The ChiNext index of start-up companies dropped 2.5 percent to 1,010.76 at the 3 p.m. close in Shenzhen and the Shenzhen index tracking small- and medium-size companies lost 0.3 percent. China’s benchmark Shanghai Composite Index advanced 1.5 percent, led by companies with large capitalizations.

“It’s only a matter of time before small caps will drop,” said Li Jun, a strategist at Central China Securities Holdings Co. in Shanghai. “Valuations are too high and that’s not justified by earnings growth.”

The ChiNext index is now valued at 56.4 times reported earnings, three times the multiple of 18.6 times for the Shanghai Composite, according to data compiled by Bloomberg. First-half profit at ChiNext companies rose 23.1 percent from a year earlier, lower than an increase of 37.5 percent for big companies, Shenyin & Wanguo Securities Co. said last week.

Chinese small-cap stocks have outperformed bigger companies over the past year as the government’s push to bolster industries such as alternative energy and satellite navigation has encouraged money to flow into start-up companies. The Shenzhen index has surged 43 percent over the past 12 months, compared with a 5.8 percent drop for the Shanghai Composite. The rally has prompted caution from brokerages including Citic Securities Co., which last week said small-cap stocks are due for a “correction.”

Smaller companies will have more tradable shares released into the market in November, when the period during which pre- initial public offering shareholders cannot sell their shares ends, according to Industrial Securities Co.

Smallcaps Flood

Shares of smallcaps worth 91.9 billion yuan ($13.5 billion) will become tradable in November, wrote Nie Qinglian, an analyst at Industrial Securities, in a report dated Sept. 4. That compares with the monthly average of 20 billion yuan for the whole market before November, according to the report.

“With the selling pressure of unlocked shares from Shenzhen middle and small cap board and ChiNext in the months ahead, there may be pressure for capital to flow out of (expensive) small-caps in Shenzhen to the (cheaper) large-caps in Shanghai,” Shirley Zhao and Michael Kurtz, analysts at Macquarie Securities Ltd., wrote in a note to clients.

The Shenzhen Stock Exchange has also banned speculation in trading of some smaller companies including Dalian Yi Qiao Marine Seeds Co. and Guangdong Palm Landscape Architecture Co., because of high volatility, the National Business Daily reported.

Dalian Yi Qiao plunged the 10 percent daily limit to 100.94 yuan in Shenzhen while Guangdong Palm slumped the maximum 10 percent to 107.87 yuan. Yi Qiao surged almost fourfold through last week from its offer price of 28.98 yuan on July 12 and Guangdong Palm almost tripled since the first day of trading on June 9.