Chinese companies aren't all guaranteed success stories, and most have suffered from the sharp fall in Chinese share prices over the past six months. But serving a fast-growing economic market gives many Alternative Investment Market (Aim) Chinese companies plenty of opportunities to produce jaw-dropping financial performances. Yet single-digit PE ratios are common. That means there's a mispricing here for investors to benefit from over the medium term.
It was in 2006 that the trickle of Chinese companies joining Aim became an influx. By October of that year there were 45 Chinese companies – enough to create the investors chronicle Aim China 30 Share index, a representative index of Aim's Chinese companies.
After that, the Chinese market really took off in quite a spectacular manner. The Shenzhen 100 index rose 327 per cent before it formed an infamous double-top formation towards the end of 2007. It then fell through the reaction low separating the two tops and subsequently dropped 36 per cent to arrive at its present precarious point. It has hit a resistance level which has temporarily halted the decline. But if the index passes through this level it could fall by as much as 35 per cent, to reach a low of 2500.
All through the index's meteoric rise analysts were predicting that the bubble would burst in China. When it happened, it dragged down most of the major world stock markets with it. To start with, the ic/Aim China index was happy to follow the Shenzhen at a reasonable distance but was unable to keep pace and opted to follow the FTSE Aim All-Share index instead. That's not surprising given that Green Dragon Gas is the 11th largest Aim company by market valuation. In fact, six constituents of the ic/Aim China index fall within the top 100 Aim companies. Although our index is travelling in the same direction as the FTSE Aim All-Share index it has managed to stay above it for most of the past 12 months. Since the start of 2008, both the FTSE Aim All-Share and the ic/Aim China 30 share indices have outperformed the Shenzhen 100.
Hardly a day goes by without China making news headlines – sometimes for tragic reasons. But the Chinese contingents on the junior market are difficult to ignore. The list of Chinese companies trading on Aim has now grown to 60 and they represent 9 per cent of Aim by market capitalisation. There is an element of safety within Aim that appeals to many of these overseas companies. Yes, they may be influenced by what is happening in China because they trade there. But they are sheltered from the major swings in direction of the local indices, lucky numbers trading and also benefit from being on a major developed stock market. The sector is growing and there are two more companies joining Aim this month. Yangtze China Investment is incorporated in the Cayman Islands and principally invests in Mainland China. It joined Aim on 14 May and raised $25.38m (£12.97m). Another company, Tai Zi Capital, is also incorporated in the Cayman Islands and intends to build a portfolio of rental investment properties in Taiwan, Hong Kong, Macau and possibly other areas of China. The property is expected to be mostly commercial with some residential. The expected market value of Tai Zi is £3m and the shares are due to start trading on 30 May.
It's not an easy ride
There have been a few Chinese Aim companies that have fallen at the first hurdle. Betex was de-listed on 19 October 2007 even though its core investments continue to perform in line with expectations. Two senior staff at the company's Beijing operation were detained over alleged involvement in the crimes of gambling and illegal operations.
EnterpriseAsia's directors, meanwhile, believed that it was no longer in the best interests of the company or its shareholders to maintain its admission to Aim and it was de-listed on 15 June 2007. Then there was IGM, which provided first- and second-generation mobile value-added services to China, Hong Kong and Macau, as well as to Malaysia, Singapore and Taiwan. IGM cancelled its quotation because of the costs of maintaining it.
Three-legged nags or wild stallions?
During one of his lectures, the late Edwin Coppock used a race-course analogy to hammer home an investment lesson. He opined that die-hard punters at the race track would hardly put their money on a three-legged nag in the hope that the rest of the field would be struck by lightning, thereby allowing the nag to win the race. Yet, as Mr Coppock pointed out, there are a lot of investors willing to do exactly that when investing in the stock market. The lure of a company whose shares are cheap and the hope that the share price will subsequently rise can be strong. Every now and then this strategy may produce results but, more often than not, it leads to disappointment. As Mr Coppock said: "Never, never, never do your buying in stocks that look cheap. If a stock can be conspicuously stronger than most others at the time of a recovery from a general stock market decline, there is something that is making that stock strong."
So, following Mr Coppock's sound advice, we've looked for wild stallions that have managed to rise in a falling market. We tracked the companies' performances over the last six-month period and came up with five companies that managed to buck the trend. This exercise could well have produced a list of companies from the same sector but quite the reverse happened. The portfolio contains a gas explorer and producer, a scrap wafer processor for photovoltaic cells and a property developer. There are also two newcomers to our list: one provides traditional and online travel services and the other digital video surveillance systems to corporate clients and whose products include digital video recorders, video servers and switch keyboards.
We have also produced a table of the worst performers since the collapse of the London stock market six months ago. Just like the stallions, the nags are from diverse fields of businesses. Financial Payment develops and integrates an electronic payment approval system, GMO provides cellular and wireless services and Bodisen manufactures pesticides and crop fertilisers. China Western is a real-estate investment company with pre-tax losses. Its investment in LITBC and Tien Shui hospital will break-even soon but overall future profitability depends on further investment to develop its property in Lanzhou. Sweet China had a reverse takeover when it acquired Essential Box Confectionery. This company is looking for more acquisitions and should announce its first set of true results in the summer (its last interim results showed administrative costs only).
One china, two stock markets
While Mr Coppock is cautionary about cheap shares, even he would be astounded by the different ratings given to Chinese shares quoted on the Shanghai and Hong Kong markets compared with those on Aim in London. Last month, the latest manipulation of the stock market by the Chinese government (specifically a reversal of a stamp duty increase) buoyed share prices by an average of nearly 10 per cent in one day. Even so, they are still around 40 per cent below October 2007's peak. Financial Times columnist John Authers reckoned that PE ratios suggested "a return to sanity" with Shanghai ‘A’ shares trading on 27 times earnings, after having recently been on 50. That’s comparable with a multiple of 15 for companies in the MSCI Emerging Markets index.
In contrast, profitable Aim-listed Chinese shares are on very low PE ratios, often single digits. Normally a low PE ratio suggests a low-growth company but many Aim-traded Chinese companies are producing explosive growth in terms of sharply higher sales and profits – or expectations of near-term and substantial profitability are high – and few of them have much, if any, debt. Consequently, investors might be wise to avoid the Shanghai casino stock market and buy certain Aim-traded Chinese shares instead.
