Chinese banks are cheap. This is a truth universally acknowledged. But it is also well known that there are good reasons for them to command a low multiple. China’s economy is slowing down; the property and credit cycles are both reaching the point where a true bust looks possible; corporate governance is horrible and involves placing blind faith in China’s Communist party.
But there is a case that Chinese financials offer the margin of safety required by value investors. Take Bank of China. It has kept churning out a return on equity of 18 per cent through the economic slowdown of the last three years, is adequately capitalised and trades at 0.87 times book value (and 5.2 times trailing earnings). It is manifestly too big to fail, so some government aid would arrive if worst comes to worst.
Does this add up to the necessary margin of safety? Possibly not. The realistic worst-case scenario is highly plausible, and seriously damaging. But it is possible to create a margin of safety by hedging. And China’s importance in the world economy means that the worst-case scenario for Bank of China is easy to hedge.