Here’s how corporate leaders can boost Hong Kong’s moribund stock market

More aggressive share buy-backs and insider buying – more common in the US – will mop up undervalued shares, instil confidence and reward long-term shareholders

Daniel Rupp

Published: 9:30am, 7 Feb, 2024

Why you can trust SCMP

After four consecutive years of decline, Hong Kong’s benchmark Hang Seng Index has dropped to levels last seen in October 2022. Financial analysts are valuing it at just 7.6 times the expected earnings this year, compared to 20.4 times for the S&P 500 in the US. Hong Kong is now one of the cheapest stock markets in the world, ranking alongside Colombia (6.6 times) and Argentina (7.6 times).

Such low valuation levels normally attract “value” investors from across the globe. But despite these deep discounts on offer, global investors have continued to lower their bids for blue chip Hong Kong stocks this year due to an array of fears about China’s property price declines, geopolitical tensions with the US and around Taiwan, and Beijing’s crackdown on private entrepreneurs.

The Hang Seng Index dropped a further 9 per cent in January despite rosy comments by China’s premier to the global business elite in Davos and the central bank chief promising interest rate cuts and stimulus.

So, what’s wrong with the Hong Kong market? Compared to the late 1990s, Hong Kong companies have stronger balance sheets, greater global competitiveness, and a more stable currency regime. Looking at the 850 largest companies in Hong Kong, our analysis reveals that about half have more cash than debt and the majority (67 per cent) remain profitable.

Looking ahead, Hang Seng Index companies are projected to grow their earnings by more than 9 per cent this year. Forty companies have a negative “enterprise value”, which means their market capitalisation is less than the value of their net cash. In essence, investors are saying Hong Kong companies are worth more dead than alive.

Hong Kong’s corporate leadership should take advantage of this market pessimism to reward both long-term shareholders and themselves. The strong balance sheets of local companies, many of which are family-controlled, provide ample ammunition to turn their excess cash into strong returns. At times of market turbulence, investors want leaders who can take advantage of volatility and allocate capital to create value.

05:39

Hong Kong stock market falls below 15,000 level, its lowest in 15 months

We propose two methods common among US CEOs, but less often deployed here: share buy-backs and insider purchases. These are ways companies can return cash to outside shareholders and boost enthusiasm for their shares. Hong Kong companies have traditionally preferred to pay out dividends due to investor demand for steady payouts and favourable local tax policies for such payouts.

According to our research based on Bloomberg data and information on the Hong Kong exchange’s website, out of more than 2,000 listed companies, 467 paid dividends over the last 12 months, while just 238 repurchased shares. Even those buy-backs have been meagre – only 52 firms repurchased more than 2 per cent of their outstanding shares. The time for boldness is now: stocks are cheap and investors are looking to business leaders to instil confidence.

The time has come for Hong Kong’s market to evolve. The experience of the US shows CEOs who embrace share buy-backs and bet on their company’s shares reap rewards. Take AutoZone for example. Since a 1991 initial public offering, the auto parts business has grown its revenue at a respectable 10 per cent per year, but its shares have done even better by returning 21 per cent annually.

Autozone’s management is focused on profitability and returning cash via buy-backs. The stock’s return for investors outpacing sales growth can be largely explained by AutoZone managers repurchasing aggressively to reduce their share count by more than 88 per cent over the last 25 years.

Over that period, on average AutoZone bought back and cancelled 8 per cent of its shares each year. Steady and aggressive repurchases compound over time. AutoZone shareholders have enjoyed a 490-fold return on their shares.

An electronic board is displayed at the entrance of a building showing the stock prices of companies listed on the Tokyo Stock Exchange in Tokyo on January 19. Photo: AFP

Significant buy-backs like these are the exception and not the rule, especially in the Hong Kong market. The Hong Kong exchange should take a page from the Tokyo Stock Exchange and pressure poorly run companies to treat shareholders better.

Japan’s corporate reforms are pushing more return of capital and have sparked a revival of global interest in stocks there. Even Warren Buffett’s Berkshire Hathaway has been buying shares in Japan, while reducing its stake in Hong Kong-listed electric vehicle maker BYD.

Hong Kong CEOs can decry the market undervaluing their firms, but talk is cheap. Which companies are taking advantage of market sell-offs to close the gap between fair value and the market price?

Hong Kong’s investors deserve better from its corporate leadership to bring life back to its once-vibrant stock market. More aggressive buy-backs and insiders buying can deliver that.

Daniel Rupp is founder and chief investment officer of Parkway Capital, based in Hong Kong