(Yicai Global) Aug. 1 -- As an increasing number of institutional investors bet on the Chinese mainland's stock markets, fundamental value-based philosophies are taking over from speculative gambles, according to a number of industry insiders.
"The long-term trend suggests mainland shares will become similar to those on the Hong Kong and American stock markets, and investors will be less interested in small caps," Huang Ju, chief strategist at Heju Investment, told Yicai Global. "For institutions, companies worth CNY2 billion (USD294 million) to CNY3 billion are not worth much attention and are skipped over in investment allocations -- the market has started to focus more on large caps instead."
Shifting From Speculation
The train of thought that every mainland stock will find favour sooner or later is about to lose traction as penny stocks with poor fundamentals emerge. As of the end of July, there were 28 companies listed on the Chinese mainland that had a share price of less than CNY2 (29 cents), according to data from researcher Wind. Those valuations are akin to penny stocks in Hong Kong.
"In the past, institutions had a strong bias for speculation and allocated heavily toward trending areas," Huang said. "Institutional investors contributed significantly to the growth enterprise rally before the stock market meltdown in 2015, but their money will not be diverted toward industry leaders that offer a higher degree of certainty. The turnover rate is declining as the holding period increases," he added.
Over the past few years, investors have become increasingly aware of the importance of a listed company's value, rather than focusing on trends, Huang continued. "Institutional investors pay more attention to the analysis of fundamentals, and both actively and passively managed funds have evolved in this direction."
Long-term investors, those who hold shares for five to 10 years, give primary focus to companies' medium- to long-term strategies, governance structure and management philosophy. This means that medium- and long-term investors are having a greater influence on share prices, which will translate into a more stable market.
Since mainland stocks have made their way into the MSCI Emerging Markets Index, foreign investors have bought more and more stock, and these mid- to long-term investors will be a key market stabilizer, said Wei Fengchun, chief strategy analyst at Bosera Asset Management. Some public companies have also announced buyback deal and their major shareholders have topped up holdings, sending a message to the market about just how much these firms are worth.
"There has been a gradual increase in the number of share buybacks since 2012, mostly by financially sound companies," said Wei, pointing to the CNY5 billion repurchases by Baoshan Iron & Steel in 2012 and 2013.
Big Caps on Top
Valuations of growth enterprises and small and mid-caps are at historical lows following recent market corrections, but judging by the price-earnings ratios and profit growth at these firms, the stocks did not possess a so-called 'growth advantage,' Wei said. This makes their future performance on the market somewhat uncertain.
"The growth enterprise market rally seen in the first quarter was mainly driven by a series of government incentives, but many challenges facing small- and medium-sized startups still remain to be addressed," added a source working at a publicly-offered fund in southern China. "This poses risks with regard to earnings sustainability, over valuations, massive share pledging and possible selloffs after the lifting of trade restrictions."
In contrast, large caps have stronger profit growth given their relatively low absolute value, Wei said, adding that investors should not be constrained by old-fashioned criteria for comparing valuations of large and small caps, and focus on industry leaders.
Editor: James Boynton