Earnings Season is Over: Lessons from China

On a quiet Wednesday, August 31st, China Telecom (CHA) Corp. Ltd., China’s last major NYSE listed player reported earnings.  The market hardly noticed as investors worried about high oil prices and news of a hefty share sale by PetroChina (PTR).

For us, however, this quiet day was much more. We can now kick back and get a sense of what is going on in China, in micro level. Because we all know that economic growth doesn’t necessarily translate into steady stock-market gains, and the Chinese market faces numerous challenges, ranging from company scandals and limited corporate disclosure to efforts by the government to sell its large stake in Chinese companies without hurting the share prices.

We have forty-four Chinese ADRs within our focus. Twenty-four NASDAQ and twenty NYSE listed. How did they do?

For the first glance the picture is not too rosy for the NASDAQ listings. Out of the twenty-four listings, nine reported better than expected earnings while the majority, almost two-third, disappointed.

Interestingly, the opposite is true for NYSE listings. Out of twenty listings, twelve cheered investors and only eight did disappoint.

What does that mean to us, individual investors?

First of all, we have to realize that NASDAQ listings represent typically the Chinese internet or internet related sectors while NYSE listings represent the more established, less risky basic material, bank and telecom sectors such as PetroChina, China Mobile or China Life Insurance.

Second, corporate earnings don’t necessarily translate into stock price appreciation.  There are two major factors driving stock prices: future earnings anticipation and market conditions.

And this is what makes investing in China little tricky. Even though established, large cap companies deliver outstanding top and bottom line growth, they offer less  chance to stock price appreciation because the government still controls most of the shares. Fear is that once the government start selling its large stake, prices will fall.  On the other hand, small cap, high growth internet companies offer tremendous  company specific risk but are immune to direct government influence.

So what is the best way to invest then?

Well, it depends on investors’ risk tolerance, time-horizon and available funds.

For risk aware, first time investors we suggest buying into funds that are large cap heavy, such as the iShares FTSE/Xinhua China 25 Index Fund (NYSE:FXI).

For more educated investors with low risk tolerance, we suggest large cap, high-dividend yield stocks such as China Mobile (CHA), Sinopec (SNP), Guangshen Rail (GSH)

And finally, for those with high risk tolerance, we suggest investing into the NASDAQ listings with extreme caution. There is no safe haven, however companies with sustained high top and bottom line growth offer outstanding investment opportunities such as Shanda or Netease do.

The hottest IPO in years: Baidu.com—What’s next?

“Bank of China (BOC.UL) named Goldman Sachs and USB on Tuesday to manage the lender’s planned $4 billion stock listing, one of the most sought-after IPO underwriting jobs in years.” — by Reuters in Aug 30.

And here are some more news for thought from the next day. Shares of Baidu.com Inc (BIDU) regained ground and closed at $81 on Aug 31st, following report that Google is loosing market share to its biggest Chinese rival. A survey by a Chinese internet research group found that Baidu.com boosted its market share in Beijing by 10.8 percent points to 52%, while its U.S. search engine share was at 33%.

What is got Baidu.com to do with Bank of China?

Well, we have to exercise caution when we hear about hot Chinese IPOs. Not that there is no reason to get excited about Chinese investment opportunities, but rather that there are a lot of lessons we can learn from Baidu’s IPO.

For those who don’t remember, let us recall what was going on Aug 5th, Friday, the first day of Baidu’s trading.

The IPO price was $27. The stock opened at $66, skyrocketed to $151 just to close the first day at $122.54.

The stock closed at $81, Aug 31th, Wednesday, as we speak. So what lessons do we learn from Baidu’s hot IPO?

First of all, the Company earned $1.4 million last year, is currently valued at around $4 billion, raising the question of whether we will ever learn not to let greed drive share prices into irrational highs. Baidu traded as high as $153 in first day’s trading.

Second, if we thought that Google (GOOG), Amazon (AMZN), and Yahoo (YHOO) would rule the cyber space, we may have to rethink our assumptions. After a five-year lull in the IPO market, investors may warm up to emerging companies again.

And lastly, in a time when Asia is showering the world with IPOs, we have to stick to the ground and not let be carried away by greed. Even in the latest wave of money betting that the profit potential amid reform of China’s banking sector outweighs a troubled legacy of lax lending and corruption.

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