Beijing is committed to professionalizing its equity market, aiming to make it a more appealing long-term investment option for households. Incentivising firms to distribute profits is a key focus of the plan, as meaningful dividends will help boost household income and spending.

It remains to be seen whether China will manage to pull off this structural shift successfully, leading to a sustained bull market in stocks.

New guidelines announced in April are designed to force listed firms to give up more profits in the form of dividends. Coming on the back of other measure to move capital out of firms and into shareholder hands, these reforms are more than just window dressing.

For now, the prospect of increased dividend payouts compel us to reiterate our bullish January call on state-backed dividend payers.

Casino no more?

Domestic investors, the majority of whom are retail investors, have long viewed China’s equity market as akin to a casino – only good for a short term punt. In line with Xi Jinping’s ‘common prosperity’ imperative, the authorities are determined to reorient the market towards value investing.

In April, the State Council issued a “Nine-Point Guideline”, aiming to improve the quality of listed companies, encourage dividend payments and close corporate governance loopholes that have sapped market confidence.

“Pushing the high-quality development of the capital market will be conducive to developing the new productive force, enriching financial products and services and creating more household wealth,” Wu Qing, Chairman of China Securities Regulatory Commission (CSRC), said after the publication of the new rules.

China’s cabinet has only issued documents directly targeting the stock market twice before: in 2004 and 2014.

On both of those occasions, a raging bull market followed. This time around, it is less clear that this will be the case. 

“Valuation with Chinese Characteristics”

Beijing has applied pressure on state-owned enterprises (SoEs) to increase their dividends or share buybacks as part of a broader reform to strengthen returns. But it has also undermined the concept – fundamental to Western markets – that stronger profits and dividends are a measure of stronger fundamentals.

At the end of 2022, the CSRC proposed using “Chinese characteristics” in valuing SoEs. This approach advocates pushing standard valuation metrics a step further to take these firms’ social impact into account. This logic rewards a loss-making SoE with a mandate to produce an unprofitable product that satisfies one of Beijing’s priority industrial policies, even if it is unable to distribute dividends to the shareholding public.

This was cynically interpreted as a call to buy SoEs. And indeed, Chinese fund managers and brokerages rushed to recommend high-quality ‘undervalued’ SoE stocks to their clients, citing sustainable investment choices.

The Wind China Valuation Index, comprising large SoEs owned by the central government and key players in the new valuation system, surged following the announcement, but then flopped last summer. It has then picked up since the start of this year. 

Enodo’s analysis is that the authorities’ push for SoEs and other listed firms to boost shareholder returns has started to bear fruit, warranting a more durable outperformance over the course of this year. We continue to see the Chinese “Dividend Aristocrats and Dividend Growers” as the best equity strategy for now.

Dividend payouts increase

Beijing’s push to increase dividend payouts is not new. As far back as 2006, the CSRC set a minimum payout level for the first time. Over the next fifteen years, China’s dividend payout ratio – total dividend paid to shareholders divided by profit – increased to around the global average.

In 2023, the State-owned Assets Supervision and Administration Commission (SASAC) added return on equity (ROE) as the performance evaluation method for central enterprises. For SoE management teams, the most effective way to increase ROE is to lower net assets by paying out profits. In addition, CSRC announced it would strengthen disclosure requirements for companies that aren’t paying dividends.

April’s “Nine-Point Guideline” stipulated that all firms should provide payout plans before they go public, specified measures to boost dividends such as more mid-year payouts, vowed to reward companies that increase their profit distribution, and promised severe punishments for firms that fail to meet dividend expectations.

From a valuation perspective, SoE stocks have single-digit price-to-earnings ratios, well below the industry average and significantly lower than private firms. This offers plenty of room to improve market valuations.

This year, the regulators took further steps. SASAC said in January that management of market values will be included in the performance appraisal system for executives of SoE’s listed subsidiaries.

That, of course, provides them with ample incentive to boost their firms' stock prices.

Conclusion

In the near term, Enodo sees increased strength in listed SoEs stocks, as well as stronger fundamental valuations as dividend payouts increase.

For this reform to fully bear fruit, households have to reap the benefit of consistent returns, boosting their income from assets, which is miniscule relative to the US. 

This would eventually likely lower their savings rate and boost consumption, as they gain confidence in this new income stream.

Improved SoE stock market performance and dividends will, of course, first benefit their biggest shareholders – the central and local governments who own the SoEs – rather than investors who buy into the revaluation of their listed subsidiaries.

The bigger question is whether it can be sustained. Under Xi Jinping, the first order for Chinese state-owned firms is to serve state priorities. Healthy firms buy up unhealthy ones and obey government plans for redistributing income and investment. 

The idea of “valuations with Chinese characteristics” is a nod to the reality that state priorities trump investors' profits. Other factors – like intensifying US-China confrontation – are set to undermine even the best-designed reforms.

Given all these concerns, Enodo Economics remains skeptical about the prospect of a sustained multi-year bull market. However, combined with the latest housing measures, we are more optimistic than before about the prospects for Chinese markets.