Hong Kong stocks have been on a tear, up nearly 60% over the past year. Are they getting pricey? Not compared to other markets.


The price-earnings ratio of the Hang Seng China Enterprises Index stands at around 9.5, just about half that of the S&P (and less than half of the Euro Stoxx 50). An even more telling comparison is the Free Cash Flow yield. For investors worried about errant accounting in Chinese companies, the FCFY is more reliable measure of company valuation than P/E. It’s harder to lie about money in the bank than about earnings under GAAP.


The HSCEI Free Cash Flow Yield swung from -10% in Q3 of 2011 to +20% in Q4 2014, while the S&P 500 and Euro Stoxx FCFY languish in the low single digits. The same is true for the Nikkei (not shown in the graph). By this acid test, China is still the cheapest big market in the world.

A note on HSCEI performance: nearly 60% of the overall index move came from six individual stocks: the top two Chinese life insurers (China Life and Ping An) and three of the top four Chinese banks (ICBC, Bank of China, China Construction Bank). The banks came back from extremely low valuations (P/E ratios of between 4 and 5) to relatively low valuations today (P/E ratios of around 6). If you think Chinese finance is a bubble waiting to burst–and Asia Unhedged has heard that bedtime story too many times–then the Hong Kong market is not for you. The most comprehensive review Asia Unhedged has found of Chinese bank credit quality estimated that in a worst-case scenario, the loss rate on Chinese bank portfolios would go no higher than 4.4%, about the same as American banks in 2010. Crushing loss rates generally are not associated with 7% economic growth, however, and the likely loss rates would be much lower.

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