When Renaissance Capital named Home Inns & Hotels Management (HMIN) 2006 IPO of the year, I wasn’t surprised one bit. HMIN, along with a large crop of China-based companies, have launched successful Chinese IPOs in 2006. Among these chinese stocks, I’ve noticed a common trend in their valuations - inflated P/E multiples.
Chinese Stocks: High Demand, Low Earnings
Stocks like HMIN experienced inflated share prices due to the high demand for domestic and overseas investors. If you bought into any Chinese stocks recently, you probably paid a slight premium for shares. High demand for Chinese stocks, coupled with little to moderate EPS, equals a high price over earnings ratio.
Where have we seen highly inflated P/E multiples before?
Of course, the 2000 technology crash. Investors bought up the tech stocks before considering the earnings potential of the newborn tech companies. We’re beginning to see that same common thread amongst the Chinese stock market. Forget about growth; let’s see some earnings!
A Chinese Stock Market Correction
Home Inns and various other Chinese IPOs have performed well in the short term, but what should we expect in the future for the chinese stock market? There are signs of a Shanghai stock market reversal, which is why many investors shouldn’t try to game the Chinese stock market. As with any endeavor, diversification is the best way to avoid devastating losses in the Chinese Stock Market. I have no idea when a correction will come, but just keep an eye out for one.
Update: Correction.
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People have been predicting a correction in the Chinese stock market for years and it hasn’t happened yet. The thing is what catalyst would start the correction in just the Chinese market (and not cause just as big of a correction in other world markets)? I can’t think of one. The Chinese have a ton of cash to burn and need a place to invest it. I talk about this in more detail in my blog post on China. http://www.zacks.com/blog/comments.php?cid=9129