China 101010: After 10 Years

After 10 Years

How long is the long-term? Most people probably say 10 years.

It was 2013. China’s stock markets were even more depressed than today. Shanghai Stock Exchange Index was trading at 9.0x (it closed at 11.7x in 2023). The CSI 300 Index, which tracks 300 Chinese domestic shares, fell 7.65% in 2013, while both S&P 500 Total Index (up 32.39%) and Nikkei 225 (up 56.72%) and the best year since 1997 and 1972, respectively. The following is from our article titled China 101010 published on Jan 6, 2014.

Without a doubt, China is in trouble as its banking system is facing mounting losses from irresponsible loans to the local governments, which soared 70% to almost US$3 trillion in less than three years. Chinese stock markets are still down 60% from the peak in 2007, and its pessimistic P/E Ratio valued at 11x is warranted: the banking sector represents 40% of the index. The only silver lining is the rapidly growing Internet companies like Baidu and Tencent. However, after an 87% surge in 2013 (CSI Overseas China Internet Index), China’s Internet stocks are no longer cheap as they are trading between 30-100x of next year’s earnings.

If this is what you think, you may miss a bargain on China’s crown jewels: a good opportunity exists exactly in these China’s old and “boring” businesses with recognized brands. Most of these brands have existed for more than 30 years - some of which even date back to the late 16th century - and they have become undeniably an important part of people’s daily lives.

During that year we came up with an idea of China 101010: a portfolio of 10 Chinese companies, trading at 10x P/E, that we can own for the next 10 years. We thought China’s stock markets 10 years ago was cheap, but investing in the benchmark index was not a good idea either, as the active investing should work better in the emerging markets like China. China 101010 was a conceptual portfolio compiled with 10 consumer-related large cap companies picked rather randomly based on the valuation. It was a buy-and-hold strategy to show how the long-term investing still works well in China. High quality active investment managers should easily beat this portfolio.

What happened to China 101010 portfolio over the last 10 years was quite insightful.

Performance

• China 101010 portfolio comfortably outperformed Shanghai Stock Exchange Index (12.7% vs. 3.6%)

• China 101010 portfolio also outperformed S&P 500 (12.7% vs. 10.1%, no currency adjustments)

Valuation

• China 101010 portfolio’s P/E ratio increased from 8.8x to 13.8x (Shanghai Stock Exchange Index’s P/E ratio also increased from 9.0x to 11.7x)

Fundamentals

• China 101010 portfolio’s EPS grew 93% on average vs. Shanghai Stock Exchange Index’s 9%

• China 101010 portfolio’s EPS growth exceeded S&P 500’s (93% vs. 78%)

China 101010’s significant outperformance was driven by Moutai, an iconic and premium liquor brand. It is now a very well-known story to the Western world, but back in 2013, very few Western investors had heard about it. (you can read our old post, Drink Moutai, And Be Merry)

China 101010’s performance has been extremely volatile. The portfolio is currently 30% below its high water mark in May 2021, but was down more than 40% at one point. It experienced 30% peak-to-trough drawdowns three times over the last 10 years.

China 101010’s peak value was May 2021. At that time, the portfolio was generating 365% return, or 23.9% p.a. while S&P 500 was up only 131%, or 12.4%. If we had liquidated the portfolio at that time, China 101010 would be remembered forever. But, actually, that is not a point.

Buffett’s Snickers

CEO of a large public company, and he's a pretty good friend with Warren Buffett, that in 2009 during the peak of the Great Recession when the economy was in pieces, he was driving around Omaha with Warren Buffett. Buffett was driving, he was a passenger, and the CEO said to Warren while driving past closed up shops, "Warren, how are we ever going to pull out of this? The country's never going to be the same after this." And Warren said, "do you know what the bestselling candy bar was in 1962?" The CEO said, "No." And Warren said, "Snickers." And Warren Said, "Do you know what was the bestselling candy bar is today?", The CEO said, "No." And Warren said, "Snickers." - Morgan Housel

The lesson from China 101010 is simple. Nothing has changed over the last 10 years. Many investors pay too much attention to “changes”, but the better way is actually investing in something that doesn’t change. China 101010 companies in 2013 are essentially doing the same thing today while they kept growing over time (the portfolio’s average EPS grew 87%, more than S&P 500’s 67%). The valuation went up and came down, driving China 101010 performance up and down as well.

It is easier to predict the growth of the fundamentals than the level of the valuation metrics the investors tend to give, so you got to have the long-term perspectives. Even though China 101010 portfolio is down 30% from the peak, these ten companies are not broken.

In fact, we could have invested in better companies than these 10 “randomly” selected cheap companies. It is also difficult to find a company that you can own forever, however, the experiences show that private equity like buy-and-hold investment strategy could work remarkably well in the inefficient market like China as long as we have a long-term capital. The market continues to be inefficient because many investors’ definition of long-term is 1 year, not 10 years.

The golden rule of investing is buy low, sell high. In order to sell high, you have to be patient. This rule is as sticky as snickers. The original China 101010 portfolio is probably not the best collection of the high quality undervalued stocks today, but the concept should still work for another 10 years… or 100 years?