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Monday, August 25, 2008

A Look at China’s P/E Ratios:

Quite a few readers have been wondering whether the relatively high P/E valuations of China’s equity markets were justified. This is my response: I would say that type of PE valuation is reasonable for most of the Chinese companies. As everyone knows, growth in China has been very robust over the past several years, and should remain strong over the next several, despite a slowdown in the rate of growth. To quickly quantify this argument we can take a look at the Shanghai SE Composite’s 2Q08 aggregate PE and divide that by China’s YoY GDP growth for the same period, and compare the data to against other markets (see chart below).

Select market PE's to underlying country's GDP growth

Source: Bloomberg

Looking at the chart above, despite China’s seemingly high PE valuations, in terms of PE to GDP they are actually the cheapest market in the set with a PE/GDP ratio of 2.1. Looking ahead, Chinese growth will continue outpacing its industrialized counterparts over the next several years, and this should help support its market. In fact, during this period we will likely see China’s domestic sector replace the export sector as the main engine of growth. This should partly be catalyzed by higher domestic incomes and growing domestic demand, coupled with a slowdown in consumption by industrialized nations. Of course from my experience, one of the big question marks for China’s market is the impact of any new government policies. However, given the expected weakness in the export sector, recent inflation moderation, and the slowdown of the GDP growth rate, I expect future policy to be accommodative to domestic growth.

Also, I will be traveling for the next couple of weeks, so I may be slow to post new entries. However, I will randomly be checking email.


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