Legendary investor Jim Rogers once wrote, “The way of the successful investor is normally to do nothing – not until you see money lying there, somewhere over in the corner, and all that is left for you to do is go over and pick it up.”
Sometimes the money can just sit there for a long time. I’ve written about “value traps,” which is when a stock or a market is “cheap” (for example, on a P/E or P/B basis) and therefore might appear to be a good value. But that cheap asset can get cheaper… and cheaper still, sometimes as the earning power (that is, the E of the P/E ratio) declines.
But other times, there’s a clear roadmap to a cheap asset rising in price.
Money lying on the floor
Hong Kong’s H-share market – where Chinese companies trade on the Hong Kong market – is one of the cheapest markets in the world. Many of the shares there also trade on the A-share market, which is where the shares of Chinese companies trade in Shanghai or Shenzhen. For reasons too complicated to get into here (but you can get access to learn more here), A-shares often trade at a big premium to H-shares… right now, the A-share market trades at about a 20 percent premium to the H-shares market. (This infographic that we put together explains it a bit better.)
Bear in mind: The same shares of 91 companies are traded on both the A-share and the H-share markets. These are the same shares of the same companies. The only difference is that these two sets of shares are available to different investors.
What follows is an example of the China H-shares discount… live and right now.
Right now, it’s possible to buy shares of a big resource company on the H-share market (which, as I mentioned, trades on the Hong Kong Exchange), for HK$6/share.
I’m going to convert that price into U.S. dollars, just so we have a point of comparison. At HK$7.76/U.S. dollar, that works out to the equivalent of US$0.77/share.
But let’s say you were a Chinese investor, in China. It’s a lot easier for you to buy shares on the A-share market (for many Chinese investors, this is the only real option). (This is one of the reasons that there’s a pricing anomaly between the A-share and H-share markets.)
So you’d be able to buy shares of this company on the A-share market for about 11.79 Chinese yuan (CNY) per share. The CNY/USD exchange rate is right around CNY6.89/USD. That means that for A-share investors, one share costs the equivalent of US$1.71 (11.79/6.89).
Remember, these are the same shares, of the same company. But one share on the H-share market costs the equivalent of US$0.77/share, and the other, on the A-share market, costs the equivalent of US$1.71/share. That’s a difference of 120 percent.
And what’s more… the shares of this company are also traded on the New York Stock Exchange (NYSE), as an American Depository Receipt (ADR). That means it’s a foreign company, but you can buy shares of it just like you’d buy shares of any other company listed on the NYSE.
Shares of the ADR of this company currently trade at about US$7.69/share. One ADR of this company is made up of 10 local shares (that is, a 10:1 ratio). That means that when you buy one share (as an ADR) in New York, it’s as if you’re buying 10 shares traded in Hong Kong.
And that’s the important thing: The ADR is like 10 H-shares (not A-shares). Remember these shares traded on the H-share market cost HK$6/share, which is about US$0.77. And for the ADR, it’s like buying 10 H-shares on the Hong Kong market. US$0.77 times 10 equals US$7.70… which is very close to the ADR share price of US$7.69.
What happens next?
What does this mean? When you’re buying the ADR, you’re buying it at the same price level as if you were buying it on the H-share market. And remember, A-shares are at a 120 percent premium to what other investors are paying for the very same shares on the Hong Kong market, or (for the ADR) in New York.
Will the discount between the H-share price (and the ADR price), and the A-share price, close? As recently as November, 2014, the two markets traded at the same price level (although some H-shares still may have traded at a discount or premium to their A-shares counterpart). And there are a lot of good reasons to think that this discount will close again, sooner rather than later – and it will affect some shares differently from others.
If this is all confusing, you can learn more by clicking here, (if you don’t want to listen to my voice, click the button beneath the video to read our research). That way you can access the research that I recently completed – as part of a brand-new research service that Truewealth Publishing is launching – that explains all of this in a lot more detail.
The example above (for Yanzhou Coal Mining (HK code 1171; NYSE: YZC) is just one example of many. (I used these shares only as an example.) There are other Chinese companies available as H-shares that trade at a discount on the Hong Kong Exchange that’s likely to contract – for a lot of reasons. We show you a few of them in our latest research report, mentioned above.
It’s like money sitting in the corner.