Please ensure Javascript is enabled for purposes of website accessibility

3 Thoughts on China’s New Star Market

By Motley Fool Staff – Updated Aug 2, 2019 at 5:49PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

China's Science and Technology Innovation Board, or Star Market, launched earlier this month but is it living up to the hype? Here are my three key takeaways.

The brand new tech-oriented exchange in Shanghai, the Star Market, is Chinese President Xi Jinping's political brainchild – created to encourage domestic technology start-ups to list locally rather than overseas (such as on the Nasdaq in the US). There's been a lot of euphoria surrounding its first trading day, but now that the dust has settled, here are my three initial thoughts.

Volatility still in play 

Chinese equity markets are often retail-driven with investors chasing news flow and momentum instead of earnings fundamentals. While there was no price limit during the first week of trading, an eventual cap of 20% per day will be set, which is double the 10% daily limit on other boards within China.

Man pointing at financial report with a pen.

Image Source: Getty Images

The Star Market will also be limited to individual investors that satisfy two main conditions: having an average daily balance of at least RMB 500,000 (US$75,000) and two years' trading experience. But given the volatile first trading day, the threshold appears quite low. The Star Market will also permit short-selling, which is likely to instigate sharper price swings.

Moral hazard and capital misallocation

Given the fanfare and palpable government support for the Star Market to succeed, it is not inconceivable to believe that China's National Team, a group of brokerages, banks and corporations, would buy shares amid a prolonged sell-off.

Besides the moral hazard created, these interventions would undermine Beijing's attempts to channel liquidity into more productive sectors of the economy. This comes after China reported GDP growth of 6.2% year-on-year in the second quarter, the lowest official rate in 27 years.

Less fundamentally driven

Unlike stocks debuting on the Shanghai and Shenzhen exchanges, which are capped at price-to-earnings (PE) multiples of 23 times the previous year's earnings, no such restriction exists on the Star Market.

On the first day of trading, many stocks on the board were valued with PE multiples in the triple digits, with the mean valuation at 52 times, a generous multiple considering none need to be profitable at the time of listing. Buying stocks at high absolute levels is not uncommon but when company valuations are inflated, capital becomes less efficient.

Foolish last thought

The 25 companies listed spent a tenth of revenue on research and development, almost four times the proportion of those listed on the mainboard. As Beijing and Washington extend the current trade dispute, it's particularly important (if not necessary) for China to cultivate domestic technology innovation. I believe that those willing to invest at high multiples – for firms that are actively engaging in innovation – will benefit more over the long term. But given that not everyone will be profitable, investors will want to exit when things look bad.

But for the Star Market to fulfill its purpose, capital deployment needs to be patient, with more of a focus on their innovation than the share price. As a stock with a similar theme, yet with less volatility, I've been a big believer in Hong Kong Exchanges and Clearing Limited (388 -1.42%). The stock exchange operator recently launched new rules that included dual-class shares for technology stocks (weighted voting rights), as well as pre-revenues for biotech companies, and also provides investors with a 2.5% dividend yield.

A version of article originally appeared on our Fool Asia site. For more coverage like this head over to Fool.hk.en.

 

The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Hong Kong Exchanges and Clearing Limited Stock Quote
Hong Kong Exchanges and Clearing Limited
388
$276.80 (-1.42%) $-4.00

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
327%
 
S&P 500 Returns
105%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/28/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.