Sure, the past few days of volatility on China's stock markets have been scary. Bill Gross, George Soros and Mohamed El-Erian all appear to be stocking up on canned goods. Freed from circuit breakers that closed trading after declines of 7 percent in two of the past four trading days, the market swung wildly in early trade this morning.
Are Chinese stocks as a whole overvalued? Not necessarily.
There are certainly a lot of companies on crazy valuations out there. Jinduicheng Molybdenum is on a price-earnings ratio of 1,129, meaning it would take more than a thousand years of profits at current levels for the producer of steel alloys to earn back its market value. Then again, on the same metric Amazon.com would take 881 years.
Let's set aside for a moment the issue of whether you should value companies on their recorded earnings, or analysts' estimates of where they're going in future (on that basis, Jinduicheng's price-earnings ratio falls to 266, and Amazon's to 136), and look at how much of China's main stock index is made up of the crazy stuff. It's an oddly reassuring picture:
Stocks in China's CSI 300 index on historic P/E valuations of more than 20 make up just 33 percent of the weighted index. That's well below the 39 percent weighting in the S&P-500, 41 percent on the Nikkei-225 and 38 percent for the FTSE-100. Then have a look at the share of the index on valuations that are traditionally regarded as cheap: fully 34 percent of the CSI 300 has a P/E multiple of less than 10, compared with 6.6 percent of the S&P, 6 percent of the Nikkei and 13 percent of the FTSE.
There are still reasons to be cautious. Banks, which can be counted on to suffer in the event of wider economic turmoil, make up 20 percent of the Chinese index, and all trade at less than 10 times earnings. Still, the median book value multiple for Chinese banks with market values above $1 billion is 0.98, close to the 0.96 figure in the U.S. That suggests if anything that they're boringly close to fair value, and certainly nowhere near the bubblicious 37 percent premium in Australia or the alarming 56 percent discount in South Korea.
Furthermore, taking out all the banks and all the stocks on the CSI 300 valued at more than a 20 times historic multiple still leaves you with a diverse universe of 110 companies spanning retailers, airlines, utilities, miners, oil companies, real estate businesses, insurers and brokers, as well as makers of drugs, automobiles, consumer electronics and sorghum liquor. While China's industrial production figures are a monthly source of worry, retail sales growth has beaten analyst estimates for four months running, suggesting the economy as a whole is far from running out of steam.
Dig down below the share price into how the constituent companies are performing financially, and it remains a reasonable picture -- return on capital for the Chinese index stands as about 5 percent, below the 6.6 percent in the S&P 500 and the 5.5 percent in the Nikkei but well ahead of the 2.9 percent on the FTSE-100.
That suggests there are some bargains to be had for any investor with a cool head and the smarts to keep away from the frothier stocks. Investments reach their most attractive valuations, in a remark often attributed to 18th century financier Nathan Mayer Rothschild, when there's blood on the streets. Right now, Shanghai's Bund is awash. It's time to buy.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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