Valuation of China A shares: raw materials

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Chinese stocks are becoming more and more expensive. From different statistics, average PE of the market is in 40s. This is not cheap compared to around PE 18 of US S&P 500. There are many reasons for that, and I’m not jumping into it. But I want to share an interesting phenomena here: these days the fund managers, and individual investors are looking for valuation safe haven, or in Chinese terms, 价值洼地.

What does that mean? Lately because some of the blue chips are so hot, they got PE of more than 50. For instance, Vanke (000002), is traded at 32 Yuan, the est. year 2007 earning is 0.60 Yuan, so the PE for 2007 is about 53. Note this is No. 1 weighted stock in Shenzhen Index (about 16%), and its market cap (more than 200 b Yuan, or $30 b) is more than top 4 US home builders combined. (Vanke is No. 1 builder in China and it has about 1% market share). China Merchants Bank (600036) has similar problems. By the way, I believe those are two best managed companies in China.

China merchants bank pic

So the blue chips are percerived to be expensive, at least from PE point of view. So what do people do? Look for low PE companies. Lately they bid up the low PE stocks such as Bao Steel (600019). Now the PEs of coal and steel stocks are on longer cheap.

We know in the developed market the raw materials stock are typically traded at about PE 10, that’s because those are cyclical companies, and the price of their products (commodities such as steel or coal) go up and down during an economy cycle. Another thing is in developed economy the demand of commodities are fairly steady, because there won’t be a huge bump of construction, or utilities. In other words, the growth rate of those industries is fairly low (single digit).

This second point is not the case in China. With the rapid growth of economy (10% GDP growth), China is thirsty of all the commodities. But we should not ignore the first point (cyclical industry). We live in a global economy. The price of commodity is not determined by China (she has big influence), but by all the participants. We could live in a commodity booming market, as Jim Rogers predicted. But even Jim acknowledges the cyclical nature of the commodity market.

Back to the China A share market. This morning I heard some coal stocks traded at PE of around 40. And the analyst on TV claims this PE is justified. I don’t know. I am not a commodity guy. But my gut feeling is those coal stocks are expensive. After all, they are just commodities 🙂

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