1 Thing You Must Avoid if You're Investing in Chinese Stocks

Increasingly, more and more long-term investors are excited about the bright prospects of Chinese stocks. And they have reason to be.

China is the world's second-largest economy and is home to an increasly affluent population of 1.4 billion people.

Its private sector is buzzing and Joe Biden's statement back in 2014 (as Vice-President) to "name me one innovative product that has come out of China" no longer holds true.

In fact, the most innovative creations in China, from the rise of social commerce to mobile QR payments, have come out of the private sector.

Herein lies the issue. If you're going to invest into the (clearly) exciting Chinese stock market, avoiding government-owned stocks is an absolute must.

Conflicting interests

Why's that the case? It's simple. When you own shares in a large state-owned bank, such as China Construction Bank or Bank of China, you are really owning shares in a lever of the Chinese economy.

A lot of the state-owned enterprises (SOEs) that are listed operate in strategic sectors such as energy, banking and telecoms.

In this respect, the interests of China, its economy and its government will always come above the interests of shareholders in these companies.

Performance has backed it up. JPMorgan, a bank, early in 2020 calculated that private-sector companies' share prices in China have outperformed state-owned ones by more than 120% in the preceding decade.

Cheap for a reason

Lots of investors will say "Oh but China banks/oil companies/telcos are cheap and have a dividend yield of 6/7/8%". That's great but what's the point of investing in an 8%-yielding stock when your initial capital is being destroyed.

China Construction Bank proves to be a perfect example of this concept. Over the past decade, its Hong Kong-listed shares have returned negative 7% on a price basis.

Yes, on a total return basis it has given investors a positive return of 59% (via all its dividends) but isn't the whole point of investing to grow our wealth?

It's a poor return when you consider Tencent shares have given investors 1,560% gains over the past 10 years.

Finally, these companies are cheap. The SOE banks regularly trade below book value (say 0.5-0.7x) and they have done for years and years. Saying that's a reason to buy them simply doesn't hold true.

In Hong Kong, nearly all professional fund managers managing investors' money avoid SOE stocks like a recently-mutated strain of Covid-19.

For retail investors everywhere, understanding this one big danger will set you up with a bigger chance of success when navigating the exciting Chinese stock market.