Speculators Are Coming Back to China

There are some great earnings results coming from smaller Chinese companies. Clearly, in this market, if a stock is going to move, the business has to beat consensus estimates and increase guidance for the future. Without outperformance, good companies are seeing their stock prices drift.

Most of the U.S.-listed Chinese companies that are beating consensus estimates are technology-related. Many of these small technology firms are crossing the 100-million-dollar mark in annual sales, which is a really good benchmark for these businesses to achieve. Critical mass is important for a company and for shareholders.

If you read the financial results of a lot of U.S.-listed Chinese companies, you’ll notice that many of these businesses are increasingly branching out into the rest of Asia for growth. Domestic operations continue to hold the lion’s share of revenues, but I’ve noticed this expansionary trend over the last few years and it’s a signal that Chinese management teams are more confident operating in other countries. As well, other countries are more willing to deal with domestic Chinese corporations, because their price points are usually so much more attractive.

Speaking of economies of scale, another trend in this group of businesses is the incredible profitability that some are achieving. For those companies where business conditions are good — they have a tendency to be really good, with large margins and exceptional bottom-line profitability. Western companies could only dream of such operating margins. It comes down to huge economies of scale, lower costs for raw materials and lower costs for labor, even for skilled workers.

The investment market for Chinese equity shares is very fickle. Speculators are highly volatile in the ownership of their positions. Sentiment as a group also tends to be susceptible to the broader stock market action in China, as well as the risk aversion of the domestic equity market.

With the broader stock market in China down, I think that a bottom will soon be achieved. Domestically, there are a lot of attractive businesses trading on U.S. stock exchanges for very reasonable valuations. There is a risk premium associated with this group and this is why valuations tend to be lower than similar U.S. public companies. Regardless, if you’re an equity speculator, you can’t ignore the opportunities in this group.

Like all sectors in the stock market, U.S.-listed Chinese shares move in and out of favor with investors. Currently, speculators are looking again at this sector, and rightly so. Even if China’s economic growth slows down over the next few years, the country is still growing by leaps and bounds for its size.