Source: Xueheng's Overseas Observations
Author: Wang Xueheng, Zhang Xi
Guoxin Securities released a research report saying that the process of expanding the Hang Seng Index to 100 constituent stocks will continue. The direction of further expansion may include: 1) large-scale Chinese and foreign consumption leaders, such as liquor, wine tourism, and luxury goods; 2) large-scale innovative drug leaders; and 3) medium-sized specialty segments, such as airlines and medical services.
The main views of Guoxin Securities are as follows:
Hang Seng Index: From the Hong Kong stock “Dow Jones” to the Hong Kong stock “S&P”
The Hang Seng Index is the main blue-chip index in the Hong Kong stock market. It was founded in 1964 by Hang Seng Bank's research department. It initially had 30 constituent stocks, mainly from traditional industries such as finance, industry, and utilities. In 1969, the Hang Seng Index was released to the public. It included a total of 33 constituent stocks. This number was maintained until 2006.
Taking advantage of the boom in issuing H shares by China's central enterprises in the Hong Kong stock market, the Hang Seng Index began an expansion and supporting weight calculation method adjustments around H shares in 2006. From 2006 to 2012, the number of constituent stocks of the Hang Seng Index increased from 33 to 50. Since most of the H-share issuers of state-owned enterprises are financial companies, there is not much difference in the sector pattern of the Hang Seng Index before and after expansion.
In 2020, the Hang Seng Index began a second round of expansion. The plan for this round of expansion is to increase the number of constituent stocks of the Hang Seng Index from 50 to 100, mainly focusing on the “new economy” (such as the Internet, pharmaceuticals, and new consumption). This expansion has greatly increased the weight of the optional consumer sector. Currently, the number of constituent stocks of the index has reached 80, and it is progressing steadily towards 100. The attributes of the Hang Seng Index are also changing from “Dow Jones” to “S&P.”
The fundamentals of the Hang Seng Index were profoundly affected by the expansion in 2020
Using the index calculation formula, we estimated the fundamentals and valuation indicators of the Hang Seng Index such as EPS and BVPS. What surprised us most was that the Hang Seng Index's BVPS fell from about 25,000 points in the first half of 2020 to 17000-18,000 points in the first 10 months of 2023.
The main reason behind this abnormal decline in BVPS is the drastic sector restructuring of the Hang Seng Index since 2020 — incorporating “new economy” companies whose PB level far exceeds that of the Hang Seng Index itself, such as Xiaomi, Ali, Meituan, Anta, and Pharma Biotech. They are highly valued and weighted, significantly increasing the PB valuation level of the Hang Seng Index and diluting the index's BVPS. Subsequently, the price of the Hang Seng Index returned to BVPS after the “new economy” valuation was adjusted.
“2019 Hang Seng Index”: Restoring the old 50-share Hang Seng Index in the “new economy” era
We assume that the Hang Seng Index will not expand in 2020 and revert to the “2019 Hang Seng Index”. The restored index points are still above 20,000, and BVPS has maintained its original long-term upward trend after 2020. Overall, compared to the actual Hang Seng Index,The fundamental value of the “2019 Hang Seng Index” is higher (BVPS 26000 vs. actual Hang Seng Index 18000; EPS 3000 vs. actual Hang Seng Index 2100) and lower valuation (PE 7x vs. actual Hang Seng Index 8x; PB 0.8x vs. actual Hang Seng Index 1x).
However, the central position of the “Actual Hang Seng Index” in the Hong Kong stock market remains unshakable: it reflects the reality of changes in the structure of the Hong Kong stock market, and is still a good summary of the Hong Kong stock market. At the same time, it is also an indisputable fact that the actual Hang Seng Index has a higher ROE; it has achieved a good balance between traditional and new things.We must not ignore the long-term strategic significance of the Hang Seng Index restructuring due to short-term fluctuations.
The future of the Hang Seng Index: Expansion continues
We believe that the process of expanding the Hang Seng Index to 100 constituent stocks will continue. According to our observation, the direction of further expansion of the Hang Seng Index may include: 1) large Chinese and foreign consumption leaders, such as liquor, wine tourism, and luxury goods; 2) large-scale innovative drug leaders; and 3) medium-sized specialty segments, such as airlines and medical services.
Risk warning:Uncertainty in macroeconomic recovery, uncertainty in industrial policy and development, uncertainty in capital market policy and environment.
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