What Not To Buy: All The PE In China

Alun Morris thinks the Chinese stock market has further to fall.

In the late 80s I remember reading that Japan's top companies traded at an average of 60 times their earnings. I didn't know much about shares then but I thought that was madness. Not as mad as 78, which was the PE ratio at the Nikkei's peak in 1989. The index is still 61% off its peak of 38915.

Today's runaway bullet train is China. Shanghai's CSI 300 index stands at 4857 or 43 times earnings, even after a 17% fall from its all time high in October. A fourfold rise from January 2006 has left those of us on the sidelines looking like china mugs.

The very un-communist success of the Chinese economy with growth averaging about 10% for the last six years certainly marks out the country as deserving the five stars on its flag and gives its stock market a premium rating. However I would never pay a PE of 43 for a company for steady 10% growth and I can't see why a whole stock market deserves it either.

The Chinese stockmarket is getting as steamy a bowl of shark's fin soup and you don't have to take my word for it -- Beijing thinks so too. In the summer they tripled the tax on share dealing to cool what has become a national obsession. The gold rush to easy profits has seen share trading accounts being opened at nine times last year's rate. The bank rate has been hiked five times in 2007, yet this cold shower for capitalists has been given the finger by economic growth hitting 12%. This has always been an unsustainable expansion rate for a major economy and the higher it goes the bigger the bump when it falls.

The head of Aberdeen Asset Management is pulling money out of China, saying "It's a liquidity and confidence-driven market and I cannot see how it will be sustained." Warren Buffett, fresh from banking a $3.5bn profit on Petrochina now thinks the Chinese market is "Too hot." Li Ka-shing, China's richest man, thought even seven months ago that "it must be a bubble."

One way UK investors have been riding this tiger is though an Exchange Traded Fund. The iShares FTSE/Xinhua China 25 tracks 25 leading Chinese companies via their Hong Kong listings. Whilst you might make a fortune from here it's far too high on rational valuations even without the risks of higher interest rates and the inherent unsatisfactoriness of a command economy. In goes iShares China 25 to the What Not To Buy table.

Here's the table to date. Cost is the best quote from an online broker.

Warning: this is not a portfolio of companies to short sell. Luck, speculation and my being plain wrong may send values up sharply.