China’s Stock Markets - A Primer and Warning Guide
Confused by China’s Stock Markets?
Don’t worry, pretty much everyone not in (and many within) mainland China is. With A, B, & H shares, a lack of transparent and trustworthy financial information and reports, confusion over true ownership of many companies (ie whether the companies are effectively still state owned or not), an investment environment very similar to Las Vegas Macau, management that often has no concern for individual shareholders (although China is far from the only place with this problem), and a competitive environment for Chinese businesses you have to see to believe, China can be a scary and confusing place to invest.
Though this primer might scare you away from investing in China entirely, it’s better to know the systematic dangers and characteristics of China’s stock markes than not. And while China’s stock markets are not likely to remain in a bubble state forever (as they are now), the information in this short primer is likely to be applicable for quite a few more years.
China Stock Share Types
First, let’s clear up some of the confusion for you. There are three main types of shares in China’s various stock markets, as described below:
- A Shares - A shares are listed in RMB in the mainland Chinese stock markets. At the moment, they can only be bought and sold by mainland Chinese people and companies, along with a small handful of foreign institutional investors.
- B Shares - B shares are listed in foreign currencies (usually $US) in the mainland Chinese stock markets. They can be traded by anyone in the world, but people from mainland China must use legal foreign currency accounts to trade in B shares.
- H Shares - H shares are companies from (incorporated in) mainland China that are listed in Hong Kong and other stock markets around the world. Only very recently have mainland Chinese investors been allowed to invest in the H shares listed on Hong Kong’s stock exchange (see Hong Kong Stock Markets Open up to Mainland Chinese Investors)
Trading Stocks in China is Like Gambling in a Casino
Few people in China buy companies based on evaluations of companies and their estimated future prospects. Even fewer still dig through the pile of publicly available stocks to find value plays or under priced growth possibilities. So how does the typical Chinese investor choose what to invest in?
- Tips from friends, brokers, or strangers
- Choosing ticker numbers they like
- Technical Analysis
Beyond this, though, is the general feeling within brokerages and among Chinese investors. Most people in China view investing within Chinese markets as a type of gambling.
Who Owns this Chinese Company?
It is rarely clear who really owns any individual company. Even though it would seem that a given company is owned by a collection of other companies / institutional investors, often these other investors are themselves largely state owned. The fact is, in today’s investing environment, it is very hard to figure out whether or not the State is indirectly the majority shareholder in any given Chinese company.
Chinese Stock Reports - Transparent or Trustworthy?
It is a well acknowledged fact within China that you can’t trust many reports that come out about a given Chinese company. Oftentimes, someone is trying to deliberately manipulate the price of the company’s stock to their own benefit.
Even financial reports are filled with problems. Regulation over the Chinese market is weak, to say the least. And recently, with the majority of profits of many companies coming from stock market ‘profits’, even accurately reported profits don’t necessarily mean anything (as they may just turn out to be paper profits a couple of years down the line).
Incredibly Competitive Environment for Chinese Companies
In China, anything that can be copied or imitated will be copied or imitated. While there is value to a company that has a culture of great service (like Ctrip), or one that provides the lowest cost anything (like Suntech Power), or standardized quality of service wherever you are (like Home Inns), don’t believe for a second that there aren’t dozens of companies trying to compete and replicate the success of any successful Chinese company.
As an example, instead of Best Buy having just a small handful of major competitors, imagine that it was in competition with a large handful of major competitors and thousands of smaller competitors. With the exception of Suntech Power (which has a large handful of major competitors), this kind of situation applies very accurately to the other two companies mentioned above.
While such companies may continue to grow at incredible rates, the outright ‘copy your business model and all of your ideas’ competition they face is far greater than similar companies would face virtually anywhere in the world.
Lack of Concern for Smaller Shareholders
Many companies around the world do not care much, if at all, for their smaller shareholders - but this is an even more pronounced tendency in China. Good luck in getting Chinese management to be careful using the money you have entrusted them with. Whether it’s outright theft (present elsewhere but again more common in China and other developing markets than already developed markets) or massive entertainment budgets (yes, we are talking about KTV, massage parlors and the like), don’t expect the typical Chinese company to be careful with your money.
Yes, many will strive for the most efficient manufacturing process and wage structure - meaning you will financially benefit from low cost Chinese labor - but when it comes to entertaining and other discretionary spending, many Chinese companies burn money. Although this is often seen as a ‘requirement for doing business’ with other Chinese companies, you aren’t going to find a Walmart style culture of not wasting money on unnecessary expenses in a significant number of Chinese public companies anytime soon.
