Summary
- Shares of the exchange-traded fund EWH () track the MSCI Hong Kong Index, which consists of stocks of large companies traded primarily on the Stock Exchange of Hong Kong Limited (SEHK).
- The EWH pays a very attractive dividend of 3.15%, which is higher than the average S&P 500 dividend.
- In this post we provide a simulation-based (sim-based) valuation of shares of the EWH.
- Our sim-based analysis suggests a fair price-to-earnings ratio of 15.30 and a fair valuation of $27.23.
- The EWH currently trades at $22.53, so it appears to be undervalued, with a potential upside of 20.86%.
The Hong Kong exchange-traded fund (EWH)
Shares of the iShares MSCI Hong Kong Index Fund (EWH) track the MSCI Hong Kong Index (). This index consists of stocks of large companies traded primarily on the Stock Exchange of Hong Kong Limited (SEHK).
Estimating a fair value for the shares
In this post we provide a simulation-based (sim-based) valuation () of shares of the EWH.
At the time of this writing, the EWH had a price-to-sales ratio of 2.45 and a price-to-earnings ratio of 12.66, which combined suggest an average net profit margin of 19.35%. The sales growth was a high 8.37%. We should note that US corporations had profit growth of around 10% on GDP growth of approximately 3% in 2018. That is over 3 times as much profit growth as sales growth.
We will conservatively estimate the sim-based earnings growth rate for the next 5 years to be 15% for the EWH, which is less than 2 times sales growth. Taking these various numbers, we arrive at a fair price-to-earnings ratio of 15.30 and a fair valuation of $27.23, as you can see in the table below. The EWH currently trades at $22.53, so it appears to be undervalued, with a potential upside of 20.86%.
The current US-China trade war
The US and China are currently embroiled in a trade war, which is marked by the imposition of tariffs on each other’s goods. Even though Hong Kong is part of China, the tariffs that the US has imposed on China do not apply to Hong Kong. Maintaining this status quo is in China’s best interest, as it adds some room for maneuvering around tariffs in the future via transshipments.
Hong Kong trades more goods in value than its gross domestic product, and half of this trade is via transshipments; i.e., goods that simply travel through Hong Kong, as opposed to being manufactured there. If the US-China trade war intensifies, Hong Kong’s share of exports to the US may increase via: transshipments from Asian countries that are not targeted by US tariffs; shipments of goods manufactured in Hong Kong; and “disguised” transshipments from China.
If the US-China trade war eases, Hong Kong’s share of open (not “under the table”) transshipments from China may increase. This is likely to play out better for Hong Kong, which is also a major financial center. Interestingly, Hong Kong's GDP relative to mainland China's peaked at 27% in the early 1990s, and fell to less than 3% in recent years. This is primarily due to the massive cumulative economic growth in mainland China since the early 1990s. And continued growth in China means growth in Hong Kong as well.
The current protests in Hong Kong
Hong Kong has a history of protests, many of which have involved violence. Usually the protests have a negative short-term impact on the economy, and are followed by a strong economic rebound soon afterwards. If history repeats itself, the EWH, which is now undervalued, should rebound quickly as soon as the protests lose steam. In fact, the current protests are a key reason why the EWH is undervalued.
Other pluses and minuses
The EWH pays a very attractive dividend of 3.15%, which is higher than the average S&P 500 dividend. Since Hong Kong is a country, it is very unlikely that it would go “bankrupt” in the sense that a company could. The companies that make up the EWH could go bankrupt, but they would have been removed from the EWH way before that happened and replaced by companies with better performance.
Moreover, Hong Kong prints its own currency, which gives it some flexibility to stimulate its economy, should that be needed. This flexibility is limited by the fact that the Hong Kong dollar is currently pegged to the US dollar, which may change in case dire circumstances emerge. Any effective stimulus would probably move the EWH up, well before the main street economy actually felt the jolt (the EWH is a leading indicator).
Disclosure
The author owns EWH shares at the time of this writing.
