Is the Chinese stock market appropriate for value investment?

Sep. 4,2019
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Warren Buffett is well-known for his trading philosophy in value investment. Frazzini et al. have studied the excess return of Buffett’s investment strategy and found that Buffett’s success is largely related to his investment style. Buffett tends to choose cheap, low-risk and high-quality stocks, namely, his investment strategy is quite stable and secure.

Compared with over 100-year history of the US stock market, China’s stock market has been established for 20 years. Buffett’s investment philosophy was introduced to China very early. However, there are few investors employing value investment strategies. The reason is that more than 70% Chinese investors are retail investors who are engaged in short-term trading. Whether value investment strategies are appropriate for China’s stock market is controversial.

Then, is the Chinese stock market appropriate for value investment? Buffett mentioned at the 2015 Berkshire Hathaway shareholders’ meeting that value investment is applicable to all markets, but when it comes to the Chinese market, he also pointed out that it was very speculative.

Buffett’s Alpha: evidence from the Chinese stock market by HU Yi et al., studies the applicability of Buffett’s value investment in China’s A-share stock market based on the data of China’s A-share market from 2005 to 2016.

The author pointed out that some investors are skeptical of value investment mainly because some value investment measures are easily manipulated by listed companies. From a policy perspective, in order to make value investment more applicable in the Chinese market, it is necessary for regulators to enhance the construction of relevant rules and regulations, reduce the company’s earnings manipulation and make the company’s disclosure more transparent and reliable. At the same time, more financial professionals are needed to improve the efficiency of information dissemination in the stock market and correct mispricing in time. In addition, financial knowledge education for investors should be enhanced so that they can analyze market information and fundamental information more comprehensively, thus improving the effectiveness of China’s stock market and attracting more domestic and foreign investors.

For the first time, the authors have constructed a comprehensive index B-score from three dimensions: cheapness, safety and quality, which is used to describe the characteristics of stocks that conform to Buffett’s value investment style.

The result shows that: firstly B-score has a strong ability to distinguish cross-sectional stock returns, and this ability is stronger than any single-dimensional index. Secondly, even after controlling the variables of market value, book-to-market ratio, turnover rate, Amihud illiquidity, and short-term reversal, B-score still has a strong predictive capacity on cross-section stock returns. Thirdly, the B-score strategy has good robustness. Whether it is a bull market or a bear market, optimistic or pessimistic, the B-score long-short portfolio can achieve significant excess returns. Fourthly, the extreme market environment from 2015 to 2016 has a certain impact on the profitability of the B-score strategy, but generally speaking, the B-score strategy can still achieve positive returns. Fifthly, the B-score strategy has good continuity. When the holding period is less than one year, the B-score long-short portfolio has a significantly positive return. Sixthly, unlike most market anomalies, the profit source of B-score strategy is not mainly from the short position, but the long position and short position accounts for about half each, and after considering transaction costs, the long position still generates significant excess returns. The reason why B-score can distinguish cross-sectional stock returns well in China’s A-share stock market is that it comprehensively considers various information, including market information and fundamental information. Compared with using a single index, comprehensive indexes are less susceptible to manipulation by companies, so the B-score strategy is relatively more robust.

Corresponding Author: HU Yi
CNKI Press Officer: ZHONG Ming

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