27 October 2016
Chinese firms offer no comfort for long-term investors, a fact reflected in their volatile share prices.
Chinese firms offer no comfort for long-term investors, a fact reflected in their volatile share prices.

Why there is no ‘forever’ when it comes to China stocks

Warren Buffett once said that his favorite holding period for an investment is “forever” if he finds a good company.

The billionaire investor had relatively little involvement in China so far. He invested in PetroChina (00857.HK) in the past but sold the stock a few years ago. E-car maker BYD (01211.HK) is pretty much the only significant Chinese holding left in Buffett’s portfolio now.

Identifying Chinese firms that one can be comfortable with for life is difficult, if not impossible. Even in the case of Hong Kong companies, if the China market is a big part of their business, investors are wary about undue volatility in stock prices.

Why are Chinese stocks so tricky? Here are a few possible answers.

First thing to note is that mainland policies keep evolving. Sometimes they help boost corporate profitability, but sometimes it could be the other way round.

Take renewable energy for example. For years, Beijing kept encouraging the use of wind power, with favorable polices like subsidies and aggressive installation targets. But from time to time, authorities have also cut the on-grid tariffs, possibly because growth was too fast and subsidy became too much of a burden.

That, along with the uncertain nature of wind sources and grid congestion, has made investing in wind power stocks a roller-coaster ride.

Leading wind power firm China Longyuan Power (00916.HK) saw its share price double between 2012 and 2013, but a plunge last year has brought it back to square one, actually a bit worse than where it started out. Promises of long-term earnings growth remain elusive.

We can also see how the anti-graft campaign has totally reversed the fortune of gaming firms and luxury retailers in the last couple of years after a great run previously.

Second, it’s about the business culture.

Chinese firms are very quick at copying what rivals are doing. When they notice someone is making good money, they all rush in without any careful thought.

This leads to excess supply and market saturation, paving the way for margin erosion. A great business soon turns into a mug’s game, and then into a money hole.

Take a look at the mainland car market. It took off in 2009 with a near 50 percent growth. But two years later, the growth came down to low single digit. This year, the “new norm” will likely continue.

During the hey days, Great Wall Motor (02333.HK) was once considered a rising star, the most promising indigenous brand, due to the car maker’s stride in Sport Utility Vehicles, one of the fastest growing and most profitable segments.

The company’s shares were on a roll for more than three years before they hit a big bump. Since April last year, Great Wall has lost about 70 percent of its market value.

In the recent report, JPMorgan described the Chinese automaker as a “falling knife”.

From a rising star to a falling knife, it took just a few years for Great Wall to lose its appeal.

Apparently many other brands, local or foreign want a bigger pie of the lucrative SUV market.

Rival Geely will launch a Volvo-designed SUV in March and Volkswagen is planning 5-6 budget SUV models, JPMorgan noted, predicting that Great Wall’s margin erosion will continue and that earnings will actually drop in 2017.

Similar cases occurred in many other sectors — handset making, sportswear retailing, electric appliances and solar energy, as well as the now deeply-troubled coal and steel industries.

Mainland stocks are known for notoriously short-lived fortunes. The top gainers today could be the top losers the very next day.

Given this, who can blame foreign investors for being wary about Chinese firms!

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EJ Insight writer

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