China's Breakout

Chinese ETF iShares China 25 (UK: FXC.L; US: FXI) has recently broken out above its 100 day high resistance line indicating a possible uptrend:

 

Fundamentals

At present the fund pays a 2.52% dividend with an annual expense ratio of 0.74%.

Year	Dividend (US$)
2005	1.45
2006	1.61
2007	2.13
2008	2.32
2009	1.63
2010	1.78
2011	1.97
2012 (to date)	2.35

Dividends in US$ are up 62% since 2005 (annualised growth 7.1%p/a) and are currently above the 2008 high with potentially one further dividend payout this year.

The average PE ratio is an estimated 9.57 which looks good value. If you recall from a recent post on the problem with dividends we can come up with an adjusted yield to incorporate these retained earnings:

Adjusted Yield = Dividend Yield + [ (Earnings Yield - Dividend Yield) / 2 ]

Where: Earnings Yield = 1/ PE ratio

= 2.52% + [ ((1/9.57) - 2.52%) / 2 ]

= 6.49%

This looks healthy and the fund doesn't look overpriced on this measure.

The IMF forecast a real growth rate for China at 8.5% a year going forward. Adjusting this for margin of error (50%) and nominalising it with an inflation estimate of 2.5% gives us a nominal growth forecast of 6.75%.

Using our model:

Expected Return = Dividend Yield + Adjusted Growth Rate - Adjustment Rate - Expenses

Gives:

2.52% + 6.75% - 0.00% - 0.74%

= 8.53% (Currently the highest or all iShares ETFs)

So far, so good.

 

Holdings

 

The chart below shows the sector weightings of the index:

 

As you can see financials make up 57% of the index (this compares 19% for the FTSE100 and 15% for the S&P 500). How much bad debt China Construction Bank, the Industrial and Commercial Bank of China,  and Bank of China have is anyone's guess. How much of this is already factored into the valuations already? Valuations look attractive but with reports of a looming debt crisis in China and the heavy weighting towards financial stocks this looks a risky investment. I certainly won't be betting the ranch.