Chinese B shares listed in Shanghai and Shenzhen are more open to foreign investors, but the most transparent markets for Chinese companies are the Hong Kong-listed H shares and the ADRs listed on the New York exchanges.
Many investment pros are alarmed by the valuation of the A-share market, which traded at 44 times trailing earnings as of mid-year, and 31 times on a forward p/e basis. Simon, the sub-advisor for the Dreyfus Premier Greater China fund, says he eschews the A-market and that he's comfortable with the fund's holdings in the B- and H-share markets, which he says have valuations at about half of those of the A shares.
At mid-year, the H shares traded at 18 times 2007 estimated earnings, a valuation Simon thinks is reasonable given the projected earnings growth rate of 20% to 25% for the Hong Kong-listed universe. "We believe the EPS growth will be further revised up after the interim results are out," he says.
Both the domestic and the offshore China equity markets are impacted by events within China, and as more Chinese companies list in Hong Kong the correlation between the two groups has increased somewhat, says Simon. Conversely, the H shares are more impacted by global economic activities and capital flows such as problems with U.S. subprime loans and the yen carry trade.
Observers say Chinese equities listed in Hong Kong or New York could stumble if the domestic equity markets tanked and consumer spending suffered as a result.
For now, though, the portion of the Chinese population taking part in the economic boom is spending like Americans. And that's a big reason why China Merchants Bank is among the top holdings in the globally diversified Thornburg International Value Fund. "What separates it from other banks is its huge credit card base that will tap into rising consumerism," says fund co-manager Lei Wang.
Wang says the fund breaks down value into three different categories, and that a lot of Chinese companies fit into the emerging franchise category where expected growth rates create value even when the P/E multiple looks pricey on the surface.
The fund, which has an annualized three-year return of 27%, counts China Mobile as one of its top holdings. Wang says the wireless company has EBITDA margins of 55% and that it added 5.2 million subscribers in June. "That's more people than many countries," he says.
Red Flags
James Oberweis, co-manager of the Oberweis China Opportunities fund, says that benchmarks measuring China tend to be massively weighted toward the biggest blue chips, a group he says generally has significant state ownership. "They're boring and fully valued," he says.
Oberweis looks for smaller, cheaper companies run by entrepreneurs with material ownership stakes and personal wealth wrapped up in their companies. Many such operations aren't household names to foreign investors. One example is Li Ning, an athletic apparel maker with solid results and a product that ties into the growing buzz created by the upcoming Olympics.