It has been two years since we started investing in the Hong Kong stock market, with the majority of our portfolio comprising of, but not strictly limited to, Chinese companies.
In this article, we share some of the lessons and experiences we’ve learned over the past two years. This article is organized into two sections - one focuses on the particulars of our investment experience in the Hong Kong stock market, while the other is a discussion of key behavioural biases we encountered in our decision making during our two year journey.
Note: this article was drafted over a two month period between July and August 2024. Our statements with regards to performance are based on observations at this point in time.
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Lessons From Our Experiences In The Hong Kong Stock Market
China Isn't Just About Tech
China is the world’s second largest economy, yet only tech companies seem to come to mind when foreign investors think of Chinese companies (especially before the recent real estate crisis). When we started investing in 2022, Chinese tech stocks had already slid from their 2021 peak, but many tech companies were still trading at valuation levels which we felt were too high to be justified. Thus, most of our attention was focused on researching traditional (i.e. non-tech) companies where we felt more value investing opportunities were available. Over the past two years, our portfolio has come to comprise of a diverse range of companies operating in different sectors, including financial institutions, conglomerates, energy companies, property management services providers, highway companies, pharmaceuticals, a publishing company, a large F&B manufacturer, an interior decoration business, etc. We do have some tech stock holdings bought at prices which we believe to be undervalued, although the tech sector in total accounts for only 5% to 7% of our portfolio. Our track record is still very short, but thus far our heavily traditional portfolio has been able to substantially outperform the market.
As a whole, we feel that China has many hidden opportunities and value buys beyond the high-profile tech names.
State-Owned Companies Are Not Boring
State-owned company stocks account for around two-thirds of our portfolio by company name and approximately 75% of our total portfolio market value. Although state-owned companies are traditionally viewed as “boring” and associated with management inefficiencies and laggard performance compared with their privately-owned peers, most of the state-owned stocks we hold were able to outperform the market over the past two years, with more than half delivering an average annual return of at least 10% excluding dividends. The top performer in our portfolio, China National Offshore Oil Corporation (CNOOC)(中国海油)(HKEX: 0883), generated a price return of 120% over the past two-year period, on top of an annual dividend yield (at our cost basis) of 12%. The runner-up in our portfolio, China Unicom (中国联通)(HKEX: 0762), had a price return of 90% over the same period, on top of an annual dividend yield of 9.3%. A handful of our other state-owned picks also delivered price returns in the 25% to 55% range over this two-year period, with additional dividend yields in the 7% to 10% range.
While they were overlooked by other investors, or because they were overlooked by other investors, state-owned company stocks have been a great source of returns for us over the past couple of years. This is not to say that state-owned stocks are superior to stocks of privately-owned companies, but rather, in spite of the commonly cited drawbacks of state-owned companies, state-owned stocks can still be good investment opportunities when bought at the right price and held at the right time.
Opportunities For High Dividend Yields And Price Appreciation
While dividend yields across the world’s major financial markets usually average around 2% to 4%, we have found a good number of high dividend yield investing opportunities on the Hong Kong Stock Exchange from companies across various industries with sound fundamentals.
Unsurprisingly, many of our high dividend stocks are mature companies operating in relatively stable sectors, such as textbook publisher Xinhua Winshare (新华文轩)(HKEX: 0811)(see our Xinhua Winshare article here), which has a dividend yield of 8.9% at our cost basis; telecom companies China Unicom (中国联通)(HKEX: 0762) and China Mobile (中国移动)(0941) (see our Comparing China’s Telecom Providers article here), which have dividend yields of 9.3% and 9.8% respectively at our cost bases; highway companies Anhui Expressway (皖通高速)(HKEX: 0995) and Qilu Expressway (齐鲁高速)(HKEX: 1576), which have dividend yields of 8.7% and 8.4% respectively at our cost bases; and food manufacturer Uni-President China (统一企业中国)(HKEX: 0220), which has a dividend yield of 10.2% at our cost basis.
However, we were also able to find high-dividend opportunities in relatively more cyclical or volatile industries, including oil companies Sinopec (中国石化)(HKEX: 0386) and China National Offshore Oil Corporation (CNOOC)(中国海油)(HKEX: 0883), which have dividend yields of 9.0% and 12.0% respectively at our cost bases; coal mining company China Shenhua (中国神华)(HKEX: 1088), which has a dividend yield of 9.9% at our cost basis; property management services providers Binjiang Service Group (滨江物业)(HKEX: 3316) and New Hope Services (新希望服务)(HKEX: 3658)(see our New Hope Services article here), which have dividend yields of 8.1% and 13.7% respectively at our cost bases, fertilizer manufacturer China BlueChemical (中海石油化学)(HKEX: 3983), which has a dividend yield of 11.5% at our cost basis; medicine producer Consun Pharmaceutical (康臣药业)(HKEX: 1681), which has a dividend yield of 10% at our cost basis; and brokerage company Bright Smart Securities (耀才证券)(HKEX: 1428), which has a dividend yield of 18.8% at our cost basis. Naturally, the dividend payouts of the most volatile companies (such as Sinopec, CNOOC, China Shenhua, and China BlueChemical) fluctuate with their performance over the business cycle. Nevertheless, after examining their track records, we decided that we would still be satisfied with the companies’ dividend payouts even in their bad years at the prices at which we bought their stocks. Of course, the decision as to what dividend levels are satisfactory depends on the individual investor.
The most interesting and noteworthy aspect of our investing experience in Hong Kong-listed, high-dividend paying stocks is that we also derived substantial capital gains from many of these stocks. Examples include CNOOC, which generated a price return of 120% over the past two years along with a 2023 dividend yield of 12.0% using our cost basis; China Unicom, which generated a price return of 90% over the past two years along with a 2023 dividend yield of 9.3% using our cost basis; China Mobile, which generated a price return of 54% over two years along with a 2023 dividend yield of 9.8%; Uni-President China, which generated a return of 44% in less than one year along with a 2023 dividend yield of 10.2% at our cost basis; China Shenhua, which generated a return of 38.5% in less than one year along with a 2023 dividend yield of 9.9% at our cost basis; Xinhua Winshare, which generated a price return of 30.4% in less than one year along with a 2023 dividend yield of 8.9% at our cost basis; and New Hope Services, which generated a price return of 32.5% one year along with a 2023 dividend yield of 13.7% at our cost basis.
Our two-year experience in the Hong Kong market perhaps suggests that, contrary to common intuition, it is possible to reap high returns from both price appreciation and dividends if the right stock is bought at the right price and held at the right time.
Stepping Outside Our Comfort Zone, With A Sufficient Margin Of Error
As individual investors, our scope of expertise is naturally more limited than professional investment managers who have access to specialised teams of analysts. While the safest and most conservative route would be to invest only in industries that we are most familiar with, this would severely limit our universe of potential stocks. Over the past couple of years, we have learned to strike a balance between being conservative and investing in stocks from industries that we understand relatively well, versus investing in sectors that we are less familiar with.
We summarize some key takeaway points below.
Spend Time On Research
Needless to say, doing industry research (on top of company due diligence) is vital before investing in any stock. We try to be extra careful with companies in sectors that we are less familiar with, and make sure that we develop a sound understanding (to the best of our ability) of various industries that we are interested in investing in. While we definitely don’t become experts in these industries, taking the time and patience to understand the growth opportunities and risk factors involved has helped us to make better decisions regarding whether or not we want to invest in a certain stock, what price we would be willing to pay for the stock if we do want to invest in it, as well as our expectations for the stock in the short, medium, and long runs.
Stick To Companies That Are Easier To Understand And Value
In general, we prefer investing in companies that operate in traditional industries and have business models which are easier to understand, such as consumer goods companies, energy and utility providers, and infrastructure firms. We also prefer stocks that are easier to value by conventional valuation methods.
Allocate A Sufficient Margin Of Error
It is always prudent to allocate a margin of error when doing valuation calculations, but this is even more so important when handling stocks of companies operating in industries that we are less familiar with. We always include a margin of error in our calculations to try and reduce our potential loss in a position by entering at a more conservative, lower price. Of course, deciding on a reasonable margin of error is not easy. A margin of error that is too small won’t be very useful, while a margin of error that is too large can result in very low entry price targets that may not be reached.
Managing Illiquid Stocks
As individual investors, we don’t have liquidity constraints on which stocks we can invest in. Over the past couple of years, we profited from several investments in relatively illiquid stocks in the form of both capital appreciation and dividends. Examples include Beijing Capital Jiaye Property Services (京城佳业)(HKEX: 2210), which increased 31.7% in one year along with a dividend yield of 6.7% at our cost basis; New Hope Services (新希望服务)(HKEX: 3658), which increased 32.5% in one year along with a dividend yield of 13.7% at our cost basis; and Qilu Expressway (齐鲁高速)(HKEX: 1576), which increased 5% in six months along with a dividend yield of 8.4% at our cost basis.
While we believe that illiquid stocks should be managed with extra caution and prudence, we do want to highlight that they can present lucrative opportunities in a portfolio where such stocks are allowed. Our personal preference is to invest in illiquid stocks that have relatively mature and somewhat less cyclical businesses, along with a moderate to high dividend yield compared with listed peers on the Hong Kong Stock Exchange.
Buy Low
Probably the most timeless value investing advice is to buy low. This advice has held true throughout the course of time, and certainly holds true across all markets. One of our biggest regrets thus far is not being more aggressive with buying the stocks that we were confident in during market lows and crashes. While the investing world has placed much focus on identifying high growth Chinese stocks especially leading up to the 2021 peak, we think it is important to remember that large, outsized gains can also be made from buying fundamentally sound, overlooked stocks at low prices.
Lessons On Behavioural Biases
Don’t Let The Desire For Small Gains Wipe Out Big Opportunities
We set price targets for stocks based on fundamental analysis with a little bit of technical analysis thrown in to refine entry and exit points. A repeated mistake we made over the past two years was letting the greed for small gains get into the equation. Sometimes when we wanted to enter a stock, even though we thought the stock was undervalued, we chose to wait in case the price would drop further since the stock had previously reached a lower level recently. Of course, this did not always happen, sometimes the stock increased continuously, and we ended up missing out on the chance to buy an outperforming stock at a relatively good price. Similarly, sometimes when we wanted to add more to an existing position but the stock had already gone up in price (while still being undervalued based on our analysis), we chose to wait in case the stock would drop back down due to regret for not buying more at the lower price at which we initially bought. Again, this did not always happen, sometimes the stock continued to increase in price and we missed out on the chance to add more of an outperforming stock to our portfolio at a price that is not the lowest, but clearly still a good bargain.
From our repeated mistakes, we've learnt that it is important to keep the big picture with long run returns in mind when making buy or sell decisions, rather than being fixated on relatively small, short term gains.
Use Limits With Judgment
A common method to invest or trade with discipline is to set price limits. From our experience, a useful consideration to keep in mind is that limits are not always exactly reached. Over the past two years, we’ve encountered multiple scenarios where a stock price declined to nearly touch the buy limit we set for it, but never exactly reached the limit price. Sometimes we chose to wait for the limit to be strictly reached, but that day never came, and the stock bounced back up to embark on a strong rally. Similarly, we’ve had situations where a stock almost reached our sell limit, and we waited for the stock to reach the limit price, but that day didn’t come and the stock instead reversed and started going downwards.
Over the past two years, we've learnt the importance of finding the right balance between using limits to invest with discipline, and incorporating our own judgment to decide when we should buy or sell a stock as a supplement to the use of limits.
Consider Opportunity Costs, And Don’t Be Afraid To Cut Losses/Gains
Reflecting back on the past two years, one of our biggest mistakes was not exiting positions even though we felt that we should no longer hold onto a stock. This was admittedly due to a combination of greed (we wanted a higher gain before exiting), and more importantly, loss aversion (we wanted to at least breakeven before exiting). Of course, greed and loss aversion are not at all sound reasons to hold onto a stock when fundamentals indicate that we should instead be selling it.
Since we were (and still are) in the early stages of investing, many industries and companies were completely new to us and there were instances where we overlooked certain aspects of or made incorrect initial judgments about a company’s business model, future prospects, operating environment, quality of management, or various factors concerning the industry which the company operates in. After updating our analyses, we realized we no longer wanted to hold onto these companies (not hold at all in some cases and not hold at their current market prices in other cases), but we didn’t go through with exiting our positions for the reasons mentioned above. Occasionally, we got lucky and were able to breakeven or exit with the gain we wanted in a relatively short amount of time. More often than not, however, the stock prices of companies we wanted to sell decreased or continued to stay low for an extended period of time.
Rationally speaking, it is suboptimal to hold onto a stock that we no longer believe in. If the stock is overvalued as we believe it to be, then the market should correct itself in the long run and the price should drop, thus disallowing us from reducing our current loss or increasing our current gain. Holding onto the stock with the hope of limiting our loss or maximizing our gain means we are betting on directional short term market irrationality, which is extremely difficult (or rather, quite impossible) to predict. Similarly, if a company’s future prospects are not bright (either due to the company’s own idiosyncratic factors and/or industry-wide factors), the stock price would likely decline at least for the time frame of analysis and/or when negative news come. Holding onto the stock with the hope of selling it for a higher price in this case again is a (usually futile) bet on short term market irrationality.
Moreover, there are also significant opportunity costs involved in holding onto stocks we no longer believe in. While holding onto a stock we are not confident about and hoping that it will appreciate in price, we are foregoing the higher returns (either in the form of capital appreciation and/or dividends) that could be generated from a stock with stronger fundamentals and a more attractive valuation. Consequently, it is more optimal to exit a stock we no longer believe in by cutting losses or limiting the current gain, and switching to invest in another stock that we believe to be undervalued with sound fundamentals and good future prospects. When no attractive alternative stock is available, and given that we don't have an investment mandate to fulfil as individual investors, we feel that it is more optimal to exit an undesired stock and hold US Treasury Bills (or some other money market alternative) instead until a more attractive investment opportunity comes along, especially in the current interest rate environment.
As a whole, the past two years has taught us that it is generally better to exit an investment we are no longer confident in than to keep holding it for the sake of recovering a loss or trying to capture a bigger gain.
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