Photographer: Xaume Olleros/Bloomberg

China's Most Beaten-Down Stocks Are Still Too High for Top Fund

  • ChiNext valuations are three times higher than Shanghai market
  • Tech shares lead China's new year rout after posting 2015 gain

The Chinese stocks battered most by this year’s $1.3 trillion selloff are still too expensive for two of the most accurate forecasters of mainland markets.

The ChiNext index, a gauge of smaller Chinese technology companies that sank 24 percent this year, is valued at levels almost three times more expensive than the Shanghai market and still trades at a 2 percent premium over its own five-year average. That’s not cheap enough for Bocom International Holdings Co.’s Hao Hong, who called both the boom and bust in mainland markets last year, and Yuanta New China Fund’s Jeff Yeh, who outperformed 96 percent of peers in the past 12 months.

Despite starting 2016 with some of the world’s steepest declines, the ChiNext is still 51 percent higher than it was two years ago. Valuations, which surged to records during China’s equity bubble last year, haven’t dropped enough because major sellers have been locked out of the market by government restrictions on stake reductions, according to Hong.

“The ChiNext is still not cheap,” said Hong, the chief China strategist at Bocom International in Hong Kong. “The problem is that people expect management will continue to sell off their stakes,” as the restrictions are eventually eased. “The market will start to front run these guys,” he said.

Swings in ChiNext shares, favorite targets of China’s short-term speculators, are often more extreme than the broader Chinese market. That volatility was beneficial for investors as mainland shares climbed last year, with technology shares delivering the best return among 10 industries -- even on a risk-adjusted basis. The ChiNext dropped as much as 3.4 percent before erasing losses to trade 5.6 percent higher at Thursday’s close after 28 listed companies vowed to take action to stabilize the market.

Yet it’s working against the group in 2016 as concerns over a weak yuan and slowing economic growth send the Shanghai Composite Index to the brink of its low during a $5 trillion rout last summer. The ChiNext’s drop is about 8 percentage points deeper than the Shanghai gauge this year, while the CSI 300 Information Technology Index is the biggest loser among large-cap industry groups.

Despite its fall, the small-cap measure is valued at 33 times projected earnings over the next 12 months, versus 12 for the Shanghai Composite. The technology gauge, meanwhile, has a multiple of 27. Leshi Internet Information & Technology Corp., an Internet video provider that was one of last year’s best performers, trades at 134 times estimated earnings.

Yeh, who was adding to his Chinese technology holdings as recently as October, said he’s now turned “conservative” on the sector amid elevated valuations and potential headwinds to growth. A private Chinese services gauge slumped in December to the second-lowest reading since the series began a decade ago, dealing a blow to bets that “new economy” industries such as technology and consumer services would underpin the nation’s growth.

‘Internet Plus’

“There is no point to aggressively add tech shares unless they are back to more reasonable valuation levels,” said Yeh, who favors shares in the precision mechanics and consumer industries. His $51 million fund returned 9.4 percent in the past 12 months, according to data compiled by Bloomberg.

Technology stocks will continue to benefit from government efforts to develop the sector, according to Chang Ji-sheng, a money manager at Uni-President Assets Management in Taipei.

In July, China’s cabinet unveiled an “Internet Plus” program to link technology companies with manufacturers and rejuvenate traditional industries through the use of services such as cloud computing and artificial intelligence. Internet Plus will be promoted through the nation’s five-year plan ending 2020, President Xi Jinping said last month during the World Internet Conference in Wuzhen, near Shanghai. Earnings at ChiNext companies are projected to surge 73 percent over the next 12 months, according to analyst estimates compiled by Bloomberg.

Exiting Tech

“I am still positive on the trend of China technology stocks,” said Chang, whose NT$3.3 billion UPAMC Great China Fund has beaten 95 percent of peers over the past five years. “I will add stocks with good growth potential.”

Even after the government curbed stake sales by major shareholders, some investors are finding ways to unload their positions. MIG Technology Inc., a maker of power-surge protection gear that jumped more than 306 percent in Shenzhen trading over the past year, said in Jan. 12 filing that one of its major investors plans to sell his entire 6.59 percent stake in the company via block trades. Sinosun Technology Co., a provider of electronic password systems that’s tripled over the past 12 months, said on Jan. 11 that the controlling shareholder plans to cut up to 10 percent of its stake through block trades or a share transfer agreement.

China’s two stock exchanges will step up monitoring of share sales by major shareholders of listed companies, according to statements on their official microblogs on Wednesday.

By selling their shares away from the open market, the investors are able to skirt China’s restrictions, which cap such stake reductions at 1 percent of a company’s stock over three months. The sales, along with the overhang of even more supply once the ban is lifted, are keeping Bocom’s Hong bearish.

“I would front run them,” Hong said. “I would get rid of holdings, which are still very expensive.”

— With assistance by Amanda Wang, Allen Wan, and Cindy Wang

Before it's here, it's on the Bloomberg Terminal.