Walter Hutchens’ Blog

Here Business Week rounds up some of the China-listed companies that have reached dizzying valuations. Here Barron’s echoes the theme and provides some analysis of the causes of these sky-high valuations. They mention the inability of Chinese citizens to invest abroad and the small percentage of shares available for public trading in many PRC listcos.

I would add to that list 1) China’s excessive savings 2) China’s lack of alternative ways to invest (and thereby allocate risks and capital more diversely and efficiently), 3) investors’ belief in some implicit government backing of these firms or the markets generally, 4) not clearly irrational exuberance that many of these firms have vast potential and will continue to grow rapidly and 5) yes, a herd effect as people see the returns and want some of that for themselves—a classic bubble.

I was bearish on China’s stock markets long before the current bull market began (suggesting I’d better stick with teaching rather than day trading), but in reacting to this “China stocks are a bubble” meme, it’s important to distinguish among markets. Chinese stocks are traded both inside and outside of mainland China. Domestically-listed Chinese companies (meaning those listed in Shenzhen and Shanghai) do seem excessively valued. But foreign investors, as a rule, cannot directly buy shares in mainland-listed companies anyway (except through the narrow qualified foreign institutional investor or QFII scheme and some of its derivatives). However, many Chinese companies are listed outside the mainland, often in Hong Kong or the U.S. (and sometimes both). Prices of shares in many of those companies have increased dramatically, too, but still they are often below the utterly frightening levels of the mainland-listed firms. Seeing that a mainland-listed Chinese stock is overvalued doesn’t mean that a US-listed Chinese stock is, too. The Great Currency Wall of China keeps these markets separate. For example, a bubble in the share prices for Chinese companies listed outside of China can’t arise because investors have limited investment choices (yes, limited China concept choices, but their investment choices are not limited to China concepts—a US investor can buy Google or Bidu, whereas a Shanghai investor cannot buy Shenhua or Peabody with equal ease).

Second, not all mainland Chinese companies listed abroad are priced with obvious irrational exuberance. The Barron’s piece compares Exxon to PetroChina and the coal companies Peabody and Shenhua. It suggests in both cases that the Chinese firm is comparatively overpriced. The point may be compelling for some Chinese companies listed abroad but not true for others. For instance, China Mobile—with its 300+ million customers, prospects for many more, and forthcoming new stream (tsunami?) of revenue once 3G services finally roll out—may be quite a different story. Even at its current price, I think China Mobile compares favorably to Verizon and AT&T whose prospects seem much less enchanting.

In other words, when the bubble pops on mainland China’s domestic exchanges, the deflation that will likely follow in the prices of US-listed Chinese stocks, particularly those with solid value propositions like China Mobile and CTrip, may constitute a buying opportunity (full disclosure, I own a little CTrip and China Mobile, but also some AT&T . . . and I sold my Bidu for a small profit but more than a hundred dollars per share below its current price, so this analysis may be worth the nothing you’re paying for it).