The most populous country in the world and a rising global superpower, China's economy has grown exponentially over the last century and, barring any long-term implications from COVID-19, is poised to continue its growth trajectory over the next 10 to 20 years.
However, it's stock market is still a question mark for many retail investors - and for good reason.
It may be because there's this unfamiliarity with foreign shares and companies.
Or it may be that there's a language barrier - as many (if not most) Chinese listed companies issue announcements or financial reports in Mandarin.
It may also be that we are still scarred by the multiple scandals regarding Chinese stocks. (Recall the many corporate governance and fraud issues with S-Chips back in 2009?)
Whatever your reason, the Chinese stock market is still a relatively undiscovered goldmine - and with their economy and stock markets starting to open up, I believe now is the best time to learn more about the Chinese market and its companies.
Psst... No time to read the full guide right now? Download the PDF version here!
Three main reasons:
2nd Largest Economy in the World
- Poised to surpass the US to become the largest economy in the world
- Growth by consumption (much more sustainable) than by trade
- One of the highest GDP growth rates at 9.5% historically
Opening Up of Capital Markets in China
- Foreign ownership restrictions gradually being lifted
- China is 2nd largest stock and bond market globally
- Shares starting to be included in global indices
- Many pricing inefficiencies due to a non-mature stock market
Rising Global Dominance of Chinese Companies
- Some of the popular and most valuable companies in the world include Haidilao, Alibaba, Xiaomi, Tencent, Baidu, Bytedance, Zoom
- Huge potential to capture multibaggers
Understanding China as a Potential Investor
The Lay of the Land
China is home to 1.4 billion people - making it the most populous country on the planet. This huge country in Asia is divided into 34 parts - with the majority of them being provinces.
While it is not as pertinent to know each province and city in detail, you should note that the coastal provinces (found on the East of China) are much more urbanized, wealthy, and population-dense as compared to the inner Western parts of China.
Click here to see a map of this distinction.
Tier 1 cities (and provinces) are the most well-developed areas of China. Herein resides many consumers with a lot of spending power, and is home to many businesses and MNCs. You can expect to find cities like Shanghai (23.2 million people), Guangzhou and Beijing here.
Subsequent tiers are less well-developed and get increasingly rural.
As an investor, it is useful to note the demographics of the customers of the company you're analyzing. Are they differentiating their product mix and marketing in a Tier 1 or Tier 2 city versus in a Tier 4 city? Are their expansion plans into rural cities logical? Or should they have chosen a more urban city?
Knowing a bit of this will help you better evaluate whether growth plans of Chinese companies will be successful.
The One-Party Rule
Even though the Chinese government is known as the Communist Party of China (CPC) and has its roots in communism, modern China has much evolved in ideology and government control.
The incumbent president and General Secretary is Xi Jinping, who has been head of state since 2012. President Xi has been a pivotal figure in China's urbanization and economic growth - starting his presidency with the announcement of a large-scale project known as the Belt & Road Initiative (一带一路). His other notable directives include the "China Dream" as well as "Made in China 2025".
So why mention all this?
As an investor, it is critical that you understand how the CPC works and the thoughts of President Xi. Chinese companies are, in one way or another, controlled by the CPC and it makes sense to know the plans or initiatives the CPC has... as this could effectively foreshadow the level of growth or even survival of a company.
For instance, we at Dr Wealth has long identified that environmental protection has been one of CPC's key focuses over the last 5 years. Companies which were manufacturing goods harmful to the environment had subsequently been forced to convert their factories and operations to meet environmental standards.
Companies which were not financially strong in the first place had to take on unsustainable amounts of debt to sufficiently comply or be shut down.
Thus it is not entirely true that policy in China is "unpredictable".
Yes, policy may be hard-handed and surprising at times - but many times, you can trace it back to what the Chinese government is trying to achieve from their public official missives.
Alternatively, you may enjoy reading President Xi's thoughts on his "socialism with Chinese characteristics" form of governance in his book - The Governance of China.
In it, Xi highlights ideas that you can see were defining themes of CPC's policies. These include scientific innovation, having open and shared development, energy conservation and environmental protection, strengthening national security and so forth...
The People of China
The language of Chinese people is Mandarin (Putonghua). However, if you visit different parts of China, they may speak different Chinese dialects and engage in markedly different customs and cultures.
This is another key factor that may make or break Chinese companies' expansions into different cities. Thus, you can see that for a company to grow even within China itself... the outcomes may be very uncertain.
China's population is quickly aging - as with many other fully-developed nations.
You can see from the chart below that China is in the middle of an exponential curve in growth of the elderly population. It is also forecasted that China's percentage of elderly may even exceed that of US and UK by 2050.
China's birth rates have been declining with an average of 11.9% for the past 5 years. Contrast this with a 24.8% average just two decades ago!
Moreover, longer life expectancy also has exacerbated this problem - the median age a Chinese person can be expected to live is at 76.4 years (2017 figure). This is in line with the life expectancy of developed nations like US (78.6 years), but not as problematic as countries like South Korea (82.7 years) or Japan (84.2 years).
This presents both problems and opportunities for us investors looking into China. We fear that China's economic growth may be harder to sustain because of lesser productive workers in the economy. This will not become problematic within the next 10 years, but it is a risk if the CPC does not adjust policies for population growth and forecasts prove to be accurate.
On the other hand, there are opportunities investors may wish to seek - especially companies in the healthcare and medical space.
The Chinese Growth Story
It is important to understand how China has grown to become the global superpower it is today. Below, we have identified 4 key drivers that we think have contributed tremendous growth for China - and that we believe will continue doing so for the next decade or two:
Belt & Road Initiative (BRI)
BRI (一带一路) is a global infrastructure project aimed to help improve China's connectivity along key trade routes and improve its cooperation among countries.
BRI has undoubtedly generated enormous benefits for China (aside from its beneficiary countries). At this stage of development, domestic construction demand has been boosted as well as lending activity.
We think that once the new trade routes have been fully completed, China also stands to benefit from growth in exports, lower cost of imports, RMB appreciation, and larger investment flows.
As China's domestic growth slows, we believe BRI will become a huge contributor for its future growth.
Consumption Upgrades & A Rising Middle Class
I've done a good amount of analysis on Chinese companies now - and with most theses, growth is almost always attributed to these factors.
Since opening its economy 40 years ago, China has undergone rapid industrialization and urbanization - resulting in many Chinese getting higher-paying, higher-skilled jobs... and fast growth in household incomes among the middle class.
It is estimated that by 2022, most (54%) urban households would fall under the upper-middle class group - earning between US$16K - US$34K per year.
As such, we can see more people from the rural areas coming to live in urban cities like Shanghai and Shenzhen, and eventually migrating there.
And as disposable incomes grow, spending habits become more sophisticated. For instance, Chinese parents would be in a better position to focus on their kids' education and spend more on extra curricular activities like piano lessons or dance classes. Such a phenomena is known as "consumption upgrades" in China. For the younger generation of Chinese consumers, retail spending has grown (and is expected to continue at more than 10% growth rate).
We are of the opinion that over the next 10-20 years, as the Chinese economy continues to shift to higher-value production and a services economy fuelled by technology, more rural areas will have to be redeveloped to meet this growth. Many rural Chinese (over 40% of population) will start to enter the mass middle class and become key drivers of the economy in the future.
Liberalization of Financial and Capital Markets
We think this is the reason why it is time to look at China and Chinese stocks now.
China is home to the SECOND-largest bond and stock market in the world worth US$20 trillion - yet it is still almost entirely funded by domestic investors.
In the last 5 years, China has accelerated the opening of capital markets - with the most notable one (we think) being the 2016 A-share inclusion into global indices like the S&P DJIA, MSCI and the FTSE Russell.
With a larger global exposure, it has increased fund flows into China and makes markets (and stock valuations) more efficient.
Right now, China's stock market is *still* heavily dominated by retail investors (~90%). By investing in Chinese stocks which are under-looked and undervalued, and have good growth potential now... investors can still take advantage of market inefficiencies and earn a respectable alpha (excess returns) on their holdings as the market matures and gives them the proper valuations they deserve.
China's stock market is not what it used to be 20-30 years ago.
Back then, Chinese companies were involved in scandal after scandal. Misappropriation of assets, fraudulent accounting, taking advantage of minority shareholders, reverse mergers... they had it all.
However, we believe over the years China has cleaned up its act and introduced financial reforms with strict regulations on par with those of international bodies.
While we cannot guarantee there wouldn't be risk investing in China, we think the benefits of being IN China far outweighs any perceived risk associated with it. At Dr Wealth, we dedicate an entire segment in our due diligence to looking for such red flags unique to China, before presenting our case studies to our members.
China is quickly emerging as a tech giant, tapping on innovations like 5G, Blockchain and IoT (Internet of Things) a lot faster than most other nations.
This focus, plus a unitary-state structure, allows China to quickly adapt and essentially "leapfrog" the US in tech adoption.
For instance, China had been quick to transition from cash to mobile payments (through Alipay and WePay) when the technology was available, bypassing credit and debit cards.
In 2015, China announced a 'Made in China 2025' project that aimed to move the country from being "the world's factory"... to producing high-value products and services - especially in high-tech fields like pharmaceuticals, robotics and aerospace.
With MIC 2025, China is effectually developing EVEN MORE Chinese companies to become self-sustaining global powerhouses - besides the current BAT companies, Huawei, and a smattering of others.
According to the World IP Organization, China has filed the most number of patents overall for 2018 and 2019, almost triple that of the US at 2nd place!
New China powerhouses will emerge from this digital revolution - and this means investors have no lack of growth opportunities looking into China.
How to Invest in Chinese Shares?
Being exposed to stocks in a new market is scary…
...especially when it’s a market where the language might be different, and they don’t use the Roman characters many of us are familiar seeing.
I’ve been there before.
It took me at least one entire year before I *finally* dipped my toes in the US stock markets.
(It was a mental barrier I had to overcome, being familiar with and having invested ONLY in my local stock market as a Singaporean.)
Here, I want to help you make that jump significantly easier by helping you figure out the mechanics of how to ACTUALLY go about investing in Chinese stocks.
The Chinese Stock Market
There are only 2 domestic stock exchanges in China – Shanghai Stock Exchange (SSE) and the Shenzhen Stock Exchange (SZSE).
Most Chinese stocks (65%) are listed on these exchanges.
Companies incorporated in China can issue 3 different classes of shares (A, B, H)...
...however most Chinese stocks (65%) are A-shares and quoted in the domestic currency, CNY.
B-shares are similar to A-shares. They are listed on SSE or SZSE, but quoted in a foreign currency (ie. USD or HKD). We won’t be looking at these most of the time.
H-shares are Chinese companies listed on the Hong Kong Stock Exchange (HKEx) and are traded in Hong Kong dollars (HKD).
The Chinese stock market is not as developed as other mature stock markets like the US or the UK.
Hence, you should expect this market to be very volatile and speculative…
...as most (80-85%) of the stock market participants are retail investors or traders like you and me, rather than institutional investors.
That said, we should NOT be afraid of this volatility.
In fact - this presents us long-term investors with multiple opportunities as we can buy stocks at irrationally attractive prices and ride the Growth Dragon!
Let’s now get into the technicality of buying Chinese shares...
4 Ways to Invest in China
Direct Buying A-Shares
To buy A-shares directly, you need to either:
- check if your existing broker has a SZSE or SSE service opened for you to trade; or
- open a domestic brokerage account in China or Hong Kong.
We suggest opening with a broker in Hong Kong as it is relatively easier, with the whole process worded in English.
With a Hong Kong broker, you are allowed to trade A-shares through their platform as a result of an initiative known as the Shenzhen-Shanghai-Hong Kong stock connect.
Note that for most brokerages, you will not hold the shares in your name - but in a custodian account managed by your broker.
Some of the more well-known brokers that provide custodial access to China are Interactive Brokers and Boom Securities (in Hong Kong). These two allow foreigners (including US citizens) to open accounts with relative ease.
Once you have broker access to Chinese markets…
...the first thing you’ll notice is that China-listed stocks have stock symbols with 6 numbers.
You’ll also find that many companies will list their origin province / city / county first (ie. “Jiangsu” city followed by rest of company name “Etern”).
Chinese shares are traded like how you would any other stock.
For SSE, trading hours are 9.30am to 3pm (China Standard Time) with a 11.30am - 1pm lunch break.
For SZSE, trading hours are 9.30am to 3pm (China Standard Time) with a 12.30pm - 1pm lunch break.
Indirect Buying H-Shares through Hong Kong
Some well-known Chinese companies have bypassed SSE and SZSE and chosen to list on the Hong Kong stock exchange.
For instance, Alibaba (HKSE: 9988) and Xiaomi (HKSE: 1810).
To complicate things further, there are also Chinese companies that may be listed BOTH on the Chinese exchanges as well as the Hong Kong ones - with slight price differences.
Like PetroChina and the Bank of China.
If you’re looking to ONLY invest in Chinese stocks listed on the Hong Kong stock exchange, a wider range of brokers are available to you - including TD Ameritrade/Charles Schwab, Fidelity, and E*Trade.
However, we’d still strongly suggest opening a Hong Kong broker account (see above A-shares for broker recommendations) as many of our stock ideas will only be listed on the A-shares market.
Here’s why (it comes from a Chinese proverb)...
This (roughly) translates to “benefits are kept within the family, and not given to outsiders”.
The Chinese inherently believe that treasures that are coveted should be closely guarded.
It goes to reason that the best companies in China (especially those of national interest) are also geographically rooted within China - with the majority of its equity kept within the Chinese markets.
Buying Chinese ADRs on US Exchanges
Some Chinese companies may list on overseas exchanges - such as in the US or UK – as ADRs (American Depository Receipts) or GDRs (Global Depository Receipts).
Companies like Alibaba (NYSE: BABA) and NetEase (NASDAQ: NTES).
Granted, these Depository Receipts (DRs) allow overseas investors to invest in the Chinese market easily...
...however, they are NOT stocks.
This means that DR holders do not have the same rights as traditional shareholders and cannot vote in meetings.
I generally do not recommend investors to own an ADR or GDR as it introduces more risk and complexity to the whole equation.
If you have the option, you should seek to directly own shares of the underlying company.
Buying Chinese ETFs (Exchange-Traded Funds)
This is the most convenient out of all the above methods - as there's no stock picking involved and you can buy China-focused ETFs on most exchanges.
For Singapore investors, these are the China ETFs available on SGX:
Do note that some of these ETFs only represent segments of the China market. For instance, XT CSI300 only tracks the Top 300 A-shares listed in SSE/SZSE, while XT China50 only tracks the Top 50 Chinese companies listed in Hong Kong.
The ETF most representative of the overall China market would be XT MSCHINA - which tracks all large and mid cap Chinese companies (including H shares, B shares, Red Chips, P Chips and foreign listings).
If you are a foreign investor or have access to other markets, there are many more options to choose from. Popular market ETFs include Ishares China Large-Cap ETF (NYSEARCA: FXI), Vanguard Total China Index ETF (HKSE: 3169) and the iShares MSCI China ETF (NASDAQ: MCHI).
Besides that, there are also interesting thematic or sector ETFs if that is up your alley. Popular ones include KraneShares MSCI All China Health Care Index ETF (NYSE: KURE) which is focused on Chinese pharmaceutical companies, and KraneShares CSI China Internet ETF (NYSE: KWEB) if you're bullish on China's tech giants like Alibaba and Meituan Dianping.
ETF.com is a great resource to find an ETF you're comfortable with.
As with any other ETF, make sure there is a good amount of trading volume and take note of expense ratios (as they will eat into any returns you have!).
How to Become Confident Investing in A-Shares?
China is Everywhere
If you're living in Singapore, realize that Chinese companies are EVERYWHERE. You just got to look closely!
For instance, Alvin noticed his new flat was built by China Construction (Rich Construction is its subsidiary).
You would also see many tunnelling and MRT projects have more Chinese companies involved, vying for market share from Singapore, Korean and Japanese companies.
You have companies like Shanghai Tunnel Engineering…
Even Jewel and Terminal 1 uses air conditioning from Chinese home appliance company, Midea!
So, there is little excuse to not invest because we are unfamiliar with Chinese companies. It just takes a little more observation and reading to get comfortable with them!
Chinese Companies Are Not As Dangerous As They Once Were
The scandals regarding corporate mis-governance of Chinese companies back in 2000 has left a deep mistrust of Chinese companies for many investors.
Back then, there were many cases of misappropriation of assets, fraudulent accounting, taking advantage of minority shareholders, reverse mergers...
However, it has been 20 years on - and we believe China has cleaned up much of its act and introduced financial reforms with strict regulations on par with those of international bodies.
For instance, Chinese companies have been complying with China GAAP since 2007, and its reporting structure very similar to US GAAP. Over the years, China GAAP has been converging closer to the international reporting standard (IFRS) and is last reported to be 90% similar to IFRS. This gives us a lot of confidence that China's capital markets is becoming increasingly transparent for retail investors like us.
But don't take our word for it - the revered Charlie Munger has been investing in China for over 15 years and he said this in a recent Forbes interview,
"the strongest companies in the world are not in America... I think Chinese companies are stronger than ours and are growing faster."
That said, we don't want to blindly believe what Chinese companies (or what any public company) report on their financial statements.
So at Dr Wealth, we think it is important to do extra due diligence to check for any possible red flags with these companies in our analyses and case studies to members.
For instance, we check for things like the amount of dividends they have been paying out. Profits can easily be manipulated by companies - but when dividends are given (and if they distribute a sizeable >50% of profits as dividends), it signals that they have indeed generated enough cash on their hands.
Dividends are not the only things we look at. We also have our own set of proprietary checks that look for accounting irregularities and potential fraud.
Sometimes those are not enough. As retail investors - we do not have specialized tools or insider information and have to solely rely on the primary materials the company provides us (ie. Annual Reports, MD&A).
Thus, we cannot definitively know if top-line reporting items like revenues are being artificially inflated, or if income is actually coming from non-core operations or related-party transactions.
This is why we also rely on looking at short seller reports from companies like Bonitas and Muddy Waters.
No system of checks can guarantee that we eliminate 100% of fraudulent companies. However, they should provide us with enough information to avoid investing in things like Hyflux or the most recent exposé of Luckin Coffee.
Reliable Investing Resources for Chinese Companies
If you are investing in a Chinese company for the first time, you may not know where to look for certain pieces of information ie. Annual Report or company news.
These sites provide a plethora of information (financial statements, ratio analysis, research, corporate announcements, stock-related news, etc.) on Chinese and Hong Kong stocks, but are only displayed in Chinese...
...however, if you're using Google Chrome, the page will automatically be translated to your commonly used language.
It doesn't translate super accurately... and it doesn't translate to proper (or coherent) English sentences.
But if you can get the *gist* of what the text is trying to say... that's good enough.
Oh, by the way - you can also use Google Translate if the company has published its Annual Reports or company announcements in Mandarin!
Simply copy and paste the text into Google Translate and let Google work its magic...
For our members, to simplify this process even further, we've created a guidebook that lists the most of the important Chinese terms they need to recognize as an investor to see if the Chinese company is doing well financially and operationally.
The Shortcut Way to Invest in Chinese Stocks
As mentioned, investing in a new market is always difficult at the start.
The learning curve is steep, and there are a lot of nuances when analyzing Chinese companies. This is why we created this guide - to help you navigate this exciting new market a little easier.
The good news is, investing in China today is not as difficult or as risky as 10 or 20 years ago.
We've made some pretty good gains in Chinese stocks since 2018 - and we've recently started a monthly newsletter program called "Growth Dragons" to share some of our ideas with subscribers!
If you want to learn how we analyze Chinese companies...
Or if you just want a monthly flow of Chinese stock ideas curated and well-researched by a trusted provider...
Click on the button below to find out more about the "Growth Dragons" newsletter: