Last week, the China Securities Regulatory Commission (CSRC) announced that it will begin to publish the average price-earnings ratio (P/E ratio) of listed companies on a daily basis, compiled and issued according to industrial classification by two designated index companies. Despite its ambiguous significance, the price-earnings ratio is a well-known reference index for stock evaluation in China, both for veteran investors with over 20 years of experience and for fledgling university students trying their hand in the market.
With the P/E ratio enjoying such popularity, the CSRC now intends to guide the many medium and small investors in China towards establishing a more rational approach to investment through the release of the statistical data, and to reduce general speculation and embrace quality investment through industrial data comparison. In the past, common investors only had access to the P/E ratio of individual stocks. To know the industrial average P/E ratio, they had to buy expensive specialized investment analysis software, which is unaffordable for most small and medium investors. It is likely that some data and software suppliers will be less than thrilled with the CSRC for this decision.
Considering the weak investment competence and low level of education of China’s small and medium investors, it is not clear how many of them will download those statistics and apply them to their daily investment decisions. However, the intensification of new policies of the CSRC conveys a sense that the Commission aims to mature China’s capital market, making it more fair, transparent, and rational.
Let’s take a closer look at the valuable information contained in the latest industrial average P/E ratio. The detailed statistics include the P/E ratio of all industries on major trading markets, such as the main board, SMSE and GEM Market of the Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE). P/E ratio can be trailing PE, namely stock value divided by the accumulated profit of the four most recent financial quarters, or static PE, which is stock value divided by the net profit of the last financial year. In general, trailing PE should be lower than static PE for a company in a growth stage. Unless otherwise indicated, the P/E ratio discussed herein is trailing PE.
As of February 24th, 2012, the average P/E ratio on the main board of the SSE and SZSE was about 14, whereas those of the SMSE market and GEM market were about 28 and 38, respectively. By industry, Finance had the lowest P/E ratio, less than 9, followed by Transportation and Construction, 12 and 13 respectively. By contrast, Agriculture and IT enjoyed the highest P/E ratio at nearly 40.
The low P/E ratio of the financial industry is the product of two major factors: first, after its astronomical stock value plunged to its lowest point during the financial crisis, no investor has had the capability to revive the hundreds of billions in the mammoth sector; second, the domestic financial industry has produced bumper profits. Statistics show that the overall revenue of the domestic banking industry last year reached an astonishing RMB 1.04 trillion, an increase of 30% over the previous year, while the domestic real economy slumped. Many researchers say that the exorbitant profits of China’s banking industry came at the expense of the real economy.The high P/E ratio of Agriculture is the result of a large number of agricultural and IT companies being listed on the GEM market and the popularity of their concepts among investors. However, their investment risk is extremely high due to their shared characteristics of large annual performance fluctuations. Some enterprises disclose losses soon after going public.
Therefore, the release of the average P/E ratio data is to remind investors to manage risks and be cautious about stocks with a high P/E ratio, and at the same time suggest that investors pay attention to large-cap blue chips with lower valuation, especially finance and real estate stocks at their historic low point. However, investors should not invest by relying merely on a lower P/E ratio, as the industries are heavily regulated by macro-control policies, implying massive policy risks. In the last year, the Chinese government has delivered hefty blows to liquidity and real estate, and the stiffening mood has not changed overall, although it seems to have somewhat eased recently. Before investing in these stocks, investors would be wise to take advantage of the changes made by the CSRC, and attempt to better decipher the trend of government policies. After all, only time will tell how the market will respond.