China’s Exchanges All Follow A Profitable Pattern, And A New One’s Due To Arrive Any Minute

China’s Exchanges All Follow A Profitable Pattern, And A New One’s Due To Arrive Any Minute
Carl Hazeley

over 2 years ago3 mins

  • China is going to launch a brand new stock exchange – the NEEQ Select Layer – in a few months’ time.

  • The exchange’s aim is to better help small and mid-sized Chinese businesses use the stock market to raise capital, and keep them from going abroad.

  • New Chinese stock exchanges tend to perform well after launch, so there’s an opportunity to profit by buying in early – but details are scant for now.

China is going to launch a brand new stock exchange – the NEEQ Select Layer – in a few months’ time.

The exchange’s aim is to better help small and mid-sized Chinese businesses use the stock market to raise capital, and keep them from going abroad.

New Chinese stock exchanges tend to perform well after launch, so there’s an opportunity to profit by buying in early – but details are scant for now.

Late last week, the Chinese government announced plans to launch a brand new stock exchange. And while it won’t be going live for a few months, it’s worth pausing to remember the profitable opportunity that’s accompanied newly launched Chinese exchanges in the past…

What is the new exchange?

There are already a few exchanges in China, including the STAR 50, the ChiNext100, and the National Equity Exchange and Quotations (NEEQ), which comprises over 7,000 stocks representing just 2% of the total value of all Chinese stocks.

And it’s 66 of those 7,000 companies that’ll form the new exchange: the NEEQ Select Layer. They’re worth a combined $29 billion, and the majority of them are in the materials and industrials industries:

Sector breakdown of China’s new exchange.
Sector breakdown of China’s new exchange.

Why is the NEEQ Select Layer being formed?

There are currently a lot of small-to-medium early-stage Chinese companies that don’t meet the requirements to list on Chinese exchanges, which means they’re more likely to go abroad – particularly to the US – to raise money. And, as we’ve seen from recent crackdowns, the Chinese government would likely prefer to keep innovation and intellectual property closer to home. The hope, then, is that this new exchange will enable and encourage smaller Chinese companies to stay put.

Ultimately, the move should be positive for Chinese companies and their investors, even if it takes a while to pay off. The Catch-22, after all, is that major investors probably won’t pile into the new exchange until it becomes big enough to warrant the risk. But if investors can see China being more helpful than harmful to its companies, it could reduce their current fearfulness about investing in the country and give stocks a boost.

What’s the opportunity here?

Shares of the 66 companies due to join the new Chinese index shot up more than 10% on Monday, and with that rally in the rearview, you might think there’s no opportunity to be had.

But the index actually stands to keep performing well even when it’s launched, whether that’s because investors are caught up in the latest new thing, or because they’ll rebalance their portfolios to take account of a new exchange, or because passive investment funds will begin tracking the new exchange. That’s been the case whenever a new Chinese exchange has launched in the past:

Early performance of new listing boards in China
Early performance of new listing boards in China

Plus this time, there’s a kicker: the early list of companies set to be included on the new exchange comes at an attractive valuation.

It’s true that it’s trading at a trailing price-to-earnings (P/E) ratio of around 32x, which is neither cheap nor expensive compared to other newly launched exchanges or the CSI 300, the key Chinese stock market index:

China exchange valuations

But the soon-to-be-formed NEEQ Select Layer’s roughly 30% earnings growth rate puts it on a “PEG ratio” (P/E divided by earnings growth rate) of 1.1x. And while the Star 50 index is more attractive on that measure, the NEEQ Select Layer comes in cheaper than both the ChiNext100 and the CSI 300.

PEG ratios

So with history and valuation looking favorable, the stage is set for an initial rally in China’s new index. Now we just have to sit tight and wait for its actual launch, along with details on how to actually invest in it…

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