We often hear such comments: "this stock is overvalued", "A-share valuation is very cheap", so, what is valuation? We know that one of the most basic functions of the financial market is price discovery. When it comes to the stock market, it is to price the shares issued by listed companies, and its core is valuation. There are many valuation methods, which can predict the net cash inflow of the listed company in each year in the future and get its absolute value by discounting to today, but the more commonly used is relative valuation, which is what we usually call PE and Pb. P / E ratio refers to the ratio of stock price to earnings per share in an inspection period (usually 12 months); P / E ratio refers to the ratio of stock price to net assets per share. The so-called relative valuation, that is to say, the valuation is not a direct reference value of the stock price, but a vertical and horizontal comparison with the history and other stocks, so that we can see whether the current valuation level is high or low.

 

 

What is the current valuation level of Shanghai stock market?

 

 

We take the 180 index as a representative to discuss the current valuation level of Shanghai stock market.

 

First of all, we have made a vertical comparison of history since 2005. It can be seen from Figure 1 that the three phased bottoms of the valuation appeared before the completion of the split share structure reform in 2005, after the full outbreak of the financial crisis in 2008 and in the latest period. Regardless of the P / E ratio or the P / N ratio, the current valuation level of Shanghai 180 index is close to or even reaches the historical low in 2005. Take the P / E ratio as an example, it reached the lowest 10.58 times on January 5 this year, which is lower than the level in the most severe period of the financial crisis (PE 10.60 times on November 4, 2008), and even lower than that in 2005 (PE 14.33 times on December 6, 2005). We know that high valuation usually means that the market sentiment is better, investors are optimistic about the future, but at the same time, too high valuations often contain excessive bubbles. On the contrary, the current undervaluation also means a higher margin of safety and a lower market risk.

 

Figure 1: Shanghai PE and Pb are close to the lowest level in 2005

 

 

 

 

Source: Bloomberg, Shenwan research

 

 

Second, we compare the Shanghai 180 Index with the S & P 500 index and Hong Kong Hang Seng Index. We find that the volatility of P / E ratio and P / N ratio of a shares is much higher than that of the US and Hong Kong markets, and most of the time, the valuation of a shares is higher than that of the US and Hong Kong stocks, but there are several exceptions. In terms of P / E ratio, in the second half of 2005 and 2008, the P / E ratio of Shanghai 180 index was lower than that of S & P 500 index, reflecting the extreme pessimism of market sentiment at that time, but it was also on the eve of big market; since the fourth quarter of last year, the P / E ratio of Shanghai 180 was lower than that of S & P 500 index again, and the P / E ratio of Shanghai 180 and S & P 500 index in January this year was 11.50 times and 13.61 times respectively.

 

Figure 2: PE and Pb levels in Shanghai are lower than the S & P 500 index again

 

 

 

 

Source: Bloomberg, Shenwan research

 

 

How do you think of the continuous downward movement of market valuation?

 

 

Many investors have such doubts that China's GDP growth rate is much higher than that of the United States, but in the past two years, a shares have been innovating at a low level, while the U.S. shares have been rising step by step. Why is the valuation of a shares lower than that of the U.S. shares? As we know, valuation is a subjective behavior, which is mainly determined by two factors: first, investors' expectation of the economy and the company's profits. If investors are optimistic about the future economic prospects, and expect the company's profits to have a good growth momentum, and are willing to pay a higher price for the right to share future profits, they will be given a high valuation; second, considering the investment cost of risk, if the current The cost of capital is very low, the yield of other investment channels is not high, and investors think that the risk of the stock market is not big, so the stock market has a high attraction, and investors are willing to pay an overvalued value. After the four trillion yuan stimulus policy at the end of 2008, investors' pessimistic expectation of the economy was reversed, while the release of large amount of credit significantly reduced the cost of capital, so A-share took the lead in the rebound in the world; however, with the "fine adjustment" of monetary policy in the second half of 2009, investors gradually realized that China's economy was moving from a period of rapid growth to a period of structural transformation, thus the potential growth rate of the economy fell, and the profit expectation was lower However, the gradual tightening of liquidity has raised the cost of capital, and a series of internal and external uncertainties have pushed up the risk aversion mood, so the valuation level has continued to move down; while the U.S. has suffered heavy losses in the financial crisis, but its market economic system has been very mature, with strong endogenous growth, and its potential economic growth has not reached the next level like China's, but most of the time it has not As a safe haven for global capital, the valuation center of A-share market has shifted downward, which is not only lower than the level of the financial crisis in 2008, but also lower than the U.S. stock market, which is the embodiment of market will and has its rationality.

 

In addition, the rapid downward movement of market valuation last year also reflected the rational regression of the valuation bubble burst of small cap stocks. We know that the valuation of small cap stocks is usually higher than that of large cap stocks, but small cap stocks also tend to contain high risks, especially when the economic environment is adverse, the risk resistance of small companies is weaker. For example, in Hong Kong market, the valuation of small cap stocks was lower than that of large cap stocks in 2004-06. Especially after the financial crisis in 2008, the P / E ratio of small cap stocks to large cap stocks once reached 0.47, that is to say, the valuation of small cap stocks was less than half of that of large cap stocks. Since last year, A shares have also experienced the collapse of the small cap valuation bubble. We can see that the rate and magnitude of the downward movement of the small cap last year are much larger than that of the large cap stocks.