東吳大學商學院企業管理學系碩士班

碩士論文

Soochow University
Global Business Program, School of Business
Thesis

從公開市場資訊衡量轉型經濟中的中國銀行業的內在 價值 The Measurement of Chinese Banks' Intrinsic Value in its Developing Securities Market

研究生 (Student):Gareth Cottam

指導教授(Advisor): Dr. Muhan Nao (諾木汗) This dissertation is submitted to Global Business Program, School of Business, Soochow University in partial Fulfilment of the Requirements for the Degree of Master in Business Administration

May, 2011

Abstract
This research is motivated by the importance of valuing firms or equity.

Without an

assessment of value, price dictates an investor’s view of worth. An estimated value creates a reference point in which to compare with price. This comparison can then be used to base an investment decision, to buy, sell or hold. The aim of this paper is to examine valuation techniques with a focus on a practical issue of creating a valuation range rather than a single ‘precise’ number. This study is the first to examine the practical application of the Montgomery Method of valuing a company.

KEY WORDS: Value Investing, Benjamin Graham, Valuation, Montgomery Method

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Acknowledgements
I would like to express my heartfelt gratitude to the supervisor of my thesis, Dr. Muhan Nao, for his invaluable guidance and support. His time and relentless effort spent in reviewing my work are very much appreciated. My friend, Colin Fukai, was perhaps the most careful reader of multiple drafts of this manuscript. He is a true craftsman of the art of writing, and his comments are literally incorporated on every page of this paper. I thank him for his tremendous assistance. I am also truly grateful for the support I received from my family and friends and of course, to my fellow MBA classmates whom I got to know over these last few semesters. As with any work such as this, full responsibility for errors must be borne by the author. I hope those that remain are minor and few in number.

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............................................................................................................................................................................... 7  Monopoly to Competition..................... 7  Chinese Banking Industry .....1.....6  2.....5  II..................................................................................................................................2............................................................2  2.................................3...........2  2...................................4  2....................................................4  1................4  2.................................1.................................................................................1  2...........................1. 4  Research Process .................................................  1................... ii  List of Tables ............................. 3  Research Scope and Object ........................ 9  Key Performance Indicators (KPIs) for Banks ..........................................1  2.. 1  Background and Motivation .........................................5  2.................................... 10  Speculative Securities Market ........................................................................1  2..................... 14  Market Value ..............2..........................................................1  Introduction ...................... 20  Income Approach ............................................................................. 17  Valuation is not an exact science. 5  Literature Review...............5  2.... 16  Valuation objective: Why value companies? ............................................. ......................  2............... 7  China’s Financial System ........................................2........................... 9  Profit versus Profitability ..4  2...........................................................1.......... 21  iii .......................... 15  Investment Value ..............................................................................3  2........................................................................................ vii  I..........2  1............................................2  2.............................................1................... i  Acknowledgements ........................... 12  Valuation scope: What is value? .............. 15  Book Value ...................2  2...............Table of Contents Abstract ...................................3..................................1  1............................................................. 19  Valuation methods: How can companies be valued? ........................... 4  Significance of the Research ........................3  2............. 18  Bargains and Value........................................4.................................................3  1...........................2.... 7  Non-State-Owned Commercial Banks ........................... ........................................................................................................................................1  2................................................. 15  Fair Value .............................................................................3  2.. 15  Intrinsic Value ........................ vi  List of Figures .................2........................................................................... 1  Purpose of the Research ..........1....

....................................1  3.... 42  Descriptive Statistics: Montgomery Method...............3.. 29  Valuation Models .....................4............................2  4................................................................................1  4.........................2  4..3... 33  Non-State-Owned Banks ......2  2.......................1  IV..8  Market Approach ............. 25  Value.................................4.......2  4......................................................................................................2  4..................................2...............2  3....................... 25  Hypothesis ........................................ 48  Non-State-Owned ............................ 49  State-Owned ......................6  III....... 23  The World’s Most Successful Investor ..........................................................................5.......................................5  2.................................................................3..........................2  2..................................................................................................................... 53  Results of Hypothesis Testing ........... 23  Asset Approach............... 30  Analysis ................................................................ 30  Estimating Target Bank’s Value Using the Montgomery Method ...able ................................7  4....................................................................... 33  State-Owned Banks ............................................................. 24  Fundamental Analysis ......2.....................................................................................................................................................5.......................................2  4....................... 56  iv ........1  4..............1  4........4.....................5....1  3..5  4............3  2....  4...................................................................2....................................................... 36  Descriptive Statistics: Market Approach.................... 46  Non-State-Owned ..................3  3..... 48  Market Price Comparison with Value Range .......... 30  Estimating Target Bank’s Value Using the Asset Approach .................................... 31  Results of the Comparison ........................... 33  Descriptive Statistics: Asset Approach ................................................... 28  Introduction ...................................................... 47  State-Owned ...............................................5..................................................... 30  Estimating Target Bank’s Value Using the Market approach ........................................... 33  Introduction ...... 28  Sampling and Data Collection............................................................................. 38  Non-State-Owned ............................4  3..................4.........4......2  3.............................................................................................................1  4............ 26  Research Methodology.......................................................1  4............6  4....................................4  4........ 54  Summary of Findings .....................................................................3  4...................... 31  Hypothesis Testing .............................1  2..  3.................................................... 38  State-Owned ................ 51  Macro Economic Factors ......................3..............................3.............3  3...................................................................

..................................... 58  Research Implications ..............................................................................4  5.............................  5......................................................................................................... 70  v ............. 59  Recommendations for Future Research ......................................................................................... 61  References and Bibliography .......... 59  Limitations of the Research...............1  5.............................................................V.....6  Research Findings and Conclusions .....................................3  5......5  5.. 60  Conclusions .......................................................................... 58  Introduction ................. 63  Appendix ........................ 58  Considerable Differences Among Various Evaluations.........................................................................................................................2  5............................................

. 50  Table 4....................1-4 Shanghai Pudong Development Bank .........................................................................................2-4 Industrial and Commercial Bank of China .................................................. 37  Table 4...............2....................2-1 Comparison of State-Owned Bank’s Montgomery Intrinsic Value .....................2-2 Bank of China ....1-1 Comparison of Non-State-Owned Bank’s Montgomery Intrinsic Value ........1-3 China Merchants Bank ...............5......... 37  Table 4... 34  Table 4....................................2-1 Agricultural Bank of China .................................................4...........................................2-2 Bank of China ..........................................................................List of Tables Table 4...2-3 China Construction Bank ..1-1 Bank of Communications ... 51  Table 4..........3........ 52  Table 4.... 49  Table 4....................2-1 Agricultural Bank of China .......2.......................................................... 41  Table 4...... 35  Table 4...........5........2...............2-4 Industrial and Commercial Bank of China ....................................... 48  Table 4..............5...................5........................................2................4...... 49  Table 4....................... 36  Table 4........ 52  vi .2...1-1 Summary of SPDB New Shares Issue Prices ................................. 36  Table 4......................1-1 Bank of Communications ........2.............................. 50  Table 4........2......1-2 CITIC Bank ...............................................................2..............................................2-3 China Construction Bank ..... 34  Table 4........................... 51  Table 4.................................5.....5.........................................1-2 CITIC Bank ................ 35  Table 4.5..1-3 China Merchants Bank ....5................................................................................................ 47  Table 4.........................................1-4 Shanghai Pudong Development Bank ....

..................... 56  vii .........................................................List of Figures Figure 4......................................................................6-1 Comparative discrepancy between market price and intrinsic value of nonstate-owned banks ...................6-2 Comparative discrepancy between market price and intrinsic value of stateowned banks.......................... 55  Figure 4.....................................

the Enron accounting scandal and the subsequent failure of several other firms. The PRC has been credited with leading the world out of the recent global recession and in 2010 surpassed Japan as the world’s second-largest economy (Hamlin & Yanping. It seems that the financial world does not learn from its mistakes. the Asian Financial Crisis. Humanity’s tendency to succumb to “the love of money”1 can be seen from the tulip mania in the mid-16th century. 2003). KJV) 1 .1 Background and Motivation Greed is said to be a cardinal sin and yet it seems to be a recurring theme through the ages. the Wall Street Crash of 1929. continuing through the 1987 “Black Monday”. China’s economy appears to have ridden out the storm well and “is an engine of growth” for the rest of the world (Ezrati. The sub-prime crisis and ensuing GFC can be linked to reckless lending practices that led to the collapse of financial institutions.I. In 2001. 2008). such as WorldCom. 2010). the stability of the world financial system is called into question. lead to the disgrace of the accounting firm. Arthur Anderson (Healy & Palepu. In light of such recent crisis. 2008). Merrill Lynch and Lehman Brothers (Wei & Corkery. Enron and the most recent subprime collapse and subsequent Global Financial Crisis (GFC) (Sargent. Introduction 1. So what is underlying the Chinese economy? 1 New Testament: "The love of money is the root of all evil" (1 Timothy 6:10. such as Bear Stearns. 2010). The world has been rocked by one financial scandal after another.

China is still a communist country. 2010). Is this a cause for concern? What does market capitalization mean? According to Berk and DeMarzo (2007).” The investment community uses this figure in determining a company's size. The government owns or controls many of the listed and traded companies on the Shanghai.While China’s future influence on the global economy will undoubtedly increase. market capitalization is “the total dollar market value of all of a company's outstanding shares. Chinese companies are coming to dominate the financial markets of the world. the Industrial and Commercial Bank of China (ICBC) is ranked the world’s largest bank by assets and valuation while still majority state-owned (Hamlin & Yanping. Qian.” (Economist. China’s current financial system is dominated by a large banking sector that has been accused of being inefficient and poorly regulated (Allen. 2010). Shenzhen and Hong Kong stock exchanges. 2010). Investors are a silent partner with no recourse should the government decide to change policies. & Zhao. how will the world economy be affected? What if the Chinese financial system were to suffer a crisis similar to the sub-prime collapse? Is this likely? As Chris Browne (2007) writes. If China falters. the two largest insurance companies. as opposed to sales or total asset figures. “By market capitalisation. this should be tempered with an understanding that China is still a developing nation. Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share. it[China] has three of the four largest banks. the second-largest stock market and a lengthening list of investment funds. Given the 2 . Zhang. In fact.

Gordon Gekko of the 1987 film Wall Street to play the antihero of the 2010 sequel. The scope of the research is. from Institutional Investors to executives considering Mergers and Acquisitions. The research would play a key role in corporate finance as valuations can be used to assist in value enhancing financial decisions and corporate strategies.2 Purpose of the Research The purpose of this paper is to apply appropriate valuation methodologies in an attempt to measure the intrinsic value of China’s banks independently of their market price. for the previous five years of company financial 3 . Gekko reminds us all the lessons to be learned from the mantra of Wall Street: “Greed is good”. This research is of importance to anyone considering investing in China. we can determine if a margin of safety exists and estimate the risk that must be assumed if investing in China’s banks. 2008). extracted from websites and financial databases. The study is based on banks listed on the Chinese stock exchanges.speculative nature of China’s developing securities markets (Wang & Xu. where possible. By examining the value range of the banks in comparison to their market prices. 2004) (Liu & Shrestha. does this market capitalization figure represent the true value of the bank? Perhaps Hollywood producer Oliver Stone had good cause to revive his character. The aim is to examine valuation techniques with a focus on a practical issue of creating a valuation range rather than a single ‘precise’ number. It seems the cardinal rule of capitalism is that an item is worth what people will pay. but is the willingness of buyers to pay high prices a reliable indicator of value? 1. The data were collected from annual reports.

the value of the Chinese banks in the developing Chinese securities markets. These banks are highly visible in the market and due to China’s acceptance into the World Trade Organization (WTO) in 2001. it is assumed that their financial data is the easiest to source and potentially the most transparent. 4 . it is hoped that the valuation methods for private firms are improved. the scope of the research was confined to the top four ranked state-owned and non-state owned commercial banks. These valuation figures will be used to test the research hypotheses. With the results of this research and previous works such as. There is a need to establish a more accurate method to value private firms.data including the year 2010. for initial public offerings. mergers and acquisitions and so forth.3 Research Scope and Object In this study. 1.4 Significance of the Research This research adds to the existing body of knowledge regarding the valuation of banks and in particular. The Montgomery valuation method studied here also has potential uses for valuing private firms. Thavikulwat (2004) and King (2010). The importance of this effort is to establish if Chinese banks are undervalued. (200). Pratt et al. The data on each banks' market price for comparison were sourced from the Shanghai Exchange database. 1. Various valuation techniques were applied to establish a range of values for the selected banks to use in comparison with their listed market prices. overvalued or valued accordingly.

The fact that the combination is simple to use makes it more possible for analysts to test and apply the results found by this research. 4. 3. 7. if the results are consistent with possible future research. Literature and theoretical review: Review extant literature and theories regarding the banking industry.The significance of the results is that it provides an alternative valuation method by combining the Montgomery Method with existing valuation techniques. this may become another valuation method that is established in valuing companies. Research Framework: Apply the relevant extant literature and theories to determine appropriate valuation models for the Chinese banking industry. Definition of study purpose: Based on the background and motivation of this study to establish the purpose of this research. Conclusions and recommendations: 5 . and valuation methodologies. primarily sourced from annual reports. 1. 5. More specifically. Collection of appropriate financial data Gather the appropriate financial data for each of the selected banks for the past five years. 6.5 Research Process The process of this research is as follows: 1. 2. Data Analysis Apply various relevant valuation models to analyze the financial data. Test Hypothesis Apply analysis of valuation models to test hypotheses. more specifically China’s banks.

6 .Interpret the results of the data analysis. state conclusions and provide recommendations.

a central government-owned and controlled bank under the Ministry of Finance.2 Monopoly to Competition. Various definitions of value are reviewed and the reasons for and approaches to valuation are considered. How much does the rest of the world know about China? The government is still run by the Communist Party of China (CPC) and the majority of publicly traded companies were once (and still are) majority state-owned. Due to government restrictions. 2. 2. the PBOC was a monopoly.1 China’s Financial System China is considered a rapidly developing country with boundless opportunities yet China’s potential is still relatively unknown. The banking industry of China is a good example of this transition.1. but how can you know the value of these companies? How can anyone invest in China without having a sense of the value of the investment? 2.”(Brandt & Rawski. “Between 1950 and 1978. many of its industries have moved from monopoly positions towards more direct competition. China’s financial system consisted of a single bank – the People’s Bank of China (PBOC). as is the role of profit in a transitioning economy. One can look at various sources. such as the Chinese stock market and check the prices of many of its listed companies. Key performance indicators for banks are also discussed.1. 2008). its main role was to finance physical production plans. exploring its banking system and securities market.1 Chinese Banking Industry As China has moved from a planned economy to a market economy. Literature Review This section reviews the literature regarding China’s financial system.II. 7 .

2010) Allen et al. the four SCBs held 65% of deposits. (Berger. “Since the process of economic reform began in China.6% of total financial sector assets. the role of the PBOC changed. as of the end of June 2003.controlling about 93 percent of the total financial assets of the country and handling almost all financial transactions. However. Other state-owned banks are also engaging in this practice. Hasan. provided 80% of all payment and settlement services. these banks controlled 13. By the end of June 2003. the share of the market held by the shareholding commercial banks has grown substantially in the last few years. 2008) As China began its transition in 1978 from a planned economy to a market economy. (2008) was that the Big Four state-owned banks are by far the least efficient. with over 50 percent share of 8 . PBOC was formally established as China’s central bank and four state-owned banks took over the majority of commercial banking business in a gradual process from the PBOC. (2010) state that even with the entrance and growth of many domestic and foreign banks and financial institutions in recent years. & Zhou. (2008) continues stating that China's current banking reform includes partially privatizing its dominant Big Four state-owned banks and taking on minority foreign ownership of these institutions. the state-owned commercial banks (SCB) continue to dominate the market. Berger et al. and accounted for 56% of all loans granted by financial institutions in China. and that minority foreign ownership of other banks is associated with significantly improved efficiency. China’s banking system is still mainly controlled by the four largest state-owned banks.” (Wu & Chen. the Chinese banking system has grown impressively. A key finding of Berger et al.

total banking assets between them2.6 percent in 2004 and remain at this level currently). People's Bank of China: Financial Stability Report 2010 . asset utilization.9 percent of the total assets in 1993 and 54. Most of the listed non-state-owned Chinese commercial banks prefer to choose the primary domestic stock exchange in Shanghai. growth and stock Things seem to be starting to change with the decreasing weight of state-owned commercial banks in the banking system (with 73. and has the ability to control or the power to govern their financial or operational policies. 2008) 2. These banks are also called non-state-owned joint-stock commercial banks in China (JSCBs).1. Only seven non-state-owned Chinese commercial banks are listed in the two national stock exchanges in mainland China-Shanghai Stock Exchange and Shenzhen Stock Exchange. To be considered a “non-state-owned commercial banks”. leverage. each of them has an approval from Chinese banking regulators to operate as nationwide commercial banks. such as the Agricultural Bank of China and other big four banks. with the government being the largest shareholder and retaining control.1. All of these “Big Four” banks have become publicly listed and traded companies in recent years. The state controlled entities are those over which the PRC government directly holds over 50% of the outstanding shares or voting rights. these 12 commercial banks must meet several criteria. Second. First.Source: People's Bank of China 2 9 . (Wen. profitability.4 Key Performance Indicators (KPIs) for Banks Ho and Wu (2006) state that the performance criteria commonly used in financial analysis are: liquidity. 2. they are commercial banks that are not owned by the state government.3 Non-State-Owned Commercial Banks Wen (2008) defines 12 commercial banks in China as “non-state-owned commercial banks”.

Profit and profit opportunities play a major role in determining the efficient allocation of resources in any market economy. Ho and Wu (2006) adopted financial statement analysis to select ratios. eight for liquidity.performance. price to earnings and price to net current assets are among those ratios important to valuing a company.5 Profit versus Profitability McGuigan et al. leverage. two for asset utilization. In total. These alternatives are often bureaucratic and frequently lack the responsiveness to changing market conditions that a free enterprise system provides. (2007) state that in a free enterprise system. it would be necessary to develop alternative schemes on which to base resource-allocation decisions. risk bearing is also a factor.1. In addition to the role of profit in capital allocation. In their study to establish benchmark performance indicators for Australian banks. 16 for leverage. Whereas Montgomery (2010) stresses that return on equity is the most important ratio to consider. 2. 59 financial ratios were selected as the aggregated indicators for evaluating the performance of the banks. Without the market signals that profit gives. Browne (2007) advises that price to book value. The risk bearing theory of profit suggests that there is a need for profit above a competitive rate of return necessary to compensate the owners of the firm for the risk they assume when 10 . The ratios were classified in accordance with their respective attributes under the six categories: profitability. profits play an important role in guiding the decisions made by resource owners. asset utilization. growth and stock performance. liquidity. Ho and Wu (2006) determined 13 ratios for analyzing the profitability factor. 12 for growth and eight for stock performance.

(McGuigan. 2010) As the majority owners are a communist government. He refers to the effect on the second business as "inhibited earnings". The second business requires you to reinvest half the profits back into the business each year. The second business is therefore less profitable. it earns you $1 million profit. basically. There is one difference. more capital is required to generate the same level of profits.making their investments. the majority ownership of the Chinese banking industry is still in the government’s hands. Consider its desirability. Imagine you own a business that you initially invest $10 million dollars and never invest another cent into it. & Cummings. Because the managers (agents) have much less to lose than the owners (principals). Now suppose you own a different business that requires the same initial investment and produces the same series of profits. the owners frequently delegate decision-making authority to professional managers. do the state-owned banks aim to maximize profits? Should that even be a concern? Montgomery (2010) provides the following example as a thought exercise. In its first year. the next year $2 million . 11 . (Westort. 2007) However. & Harris. then $3 then $7 and then $10 million. Which business would you prefer to own? The first business is more desirable. Economic theory assumes that the objective of a firm is to maximize shareholder wealth. This creates an interesting dilemma. Moyer. Kashian. In an agency relationship. the agents often seek acceptable levels (rather than a maximum) of profit and shareholder wealth while pursuing their own self-interests. to keep it successful against its competitors.

as an emerging market.6 Speculative Securities Market China’s two domestic stock exchanges. and they have “not been effective in allocating resources in the economy.. 2008) Wang and Xu (2010) argue that with the sustainable development of China's economy. Fama and French. 2. It is the profitability of a company that should be considered in evaluating the value of a company. 1989. Some studies. 1990. 1991. China's securities market would play a more and more important role in the global securities market. 2010). Qian. examined the relationship between stock prices and a wider variety of financial and macro-economic variables (Chen et al. the amount of equity required to generate that profit is of greater importance. on the other hand. Cheung and Ng. Mukherjee and Naka. 1986. it is of important theoretical and practical significance to research on behavioral finance features of China's securities market. & Zhou. in that they are highly speculative and driven by insider trading”. (Berger.Montgomery (2010) argues that while profits are important. Schwert.1. A company’s profit figure can bear little resemblance to cash profits or cash flow. for example. Zhang. 1985. Mandelker and Tandon. Hasan. examined the impact of individual factors such as inflation. were established in 1990 (Allen. the speculative psychology and short-term investing behavior in China's securities market is clearly visible and therefore. the Shanghai Stock Exchange (SHSE) and Shenzhen Stock Exchange (SZSE). Liu and Shrestha (2008) discuss how numerous studies have analyzed how stock prices react to changes in macro-economic variables. 1989. Bulmash and Trivoli. 1990. Asprem. market dynamics and interest rates on stock prices (Fama. Others. Their scale and importance are not comparable to the banking sector. 1981. 1995). & Zhao. However. 12 .

3 13 . financial data of listed companies (especially small firms) are not reliable. the studies mentioned all focus on stock markets in developed countries. 4 At the end of the 1990s. In China. The privatization process involves restructuring the companies into incorporated companies through selling a certain proportion of shares to employees. more than 90 percent of the enterprises listed on China’s two stock exchanges remained state controlled. 2010). the general public. The literature on the stock markets of China is limited in scope. The result is stock market mania. (2010) expands that the regulatory framework for the stock market is not fully developed and information available to investors is not always transparent.1998). Qian. 2008) Allen et al. they trade like noise traders3 and purely speculate in the stock market in the absence of market transparency. With little investment knowledge or experience. other SOEs and legal entities such The term used to describe an investor who makes decisions regarding buy and sell trades without the use of fundamental data. with state-owned entities as their controlling shareholders and as of 2002 only 15 percent of stocks are associated with private corporations. Limited research has been performed on the stock markets in developing countries such as China. & Zhao. Many companies have state-owned parent companies that are not listed and are hybrids of public and private enterprises in which the government floats minority interests to raise money while retaining the bulk of shares. Zhang. (Brandt & Rawski. Allen et al. Bankruptcies are rare and the standards of corporate governance are very low. Another interesting feature of the Chinese stock market is that almost all listed firms are formerly state-owned enterprises (SOEs) 4 . especially in terms of the extent of government regulations and the investor composition (Allen. This study is also motivated by the fact that the Chinese stock market is very different from others. (2010) also asserts that individual investors constitute approximately 99 per cent of the investors in the Chinese stock market. However.

at a price around book value per share.2 Valuation scope: What is value? The definition of “value” varies in the economic literature. all the property is owned by the state and property investment was not allowed until recently. by local or central government) account for two-thirds of the total number of shares and they are not allowed to be traded. As there is no well-developed social security system in China.e. 2. Bank interest rates are regulated by the government and often kept low for the purpose of economic development. resulting in negative real interest rates. with the results that the stock market is the natural choice for investors who are looking for higher rate of returns despite the high risks involved. Liu and Ni (2002) write that the Chinese stock market is also driven by liquidity. etc. the savings rate is among the highest in the world. Depending on the context. there are several standards of value. (Liu & Shrestha. Further. A speculative securities market suggests that market prices do not represent the true value of the listed security. only one-third of the shares are allowed to be traded. these include:      Market Value Fair Value Book Value Investment Value Intrinsic Value 14 . 2008) Kang. Typically. Analysts and local investors seem to be more focused on short term earnings gains than future long term success. shares owned by legal entities and the remaining shares held by the state (i.as banks and insurance companies. As a result.

3 Book Value “With respect to a business enterprise.” International Glossary (2001) It is important to note that the firm’s book value may be an unreasonable measure of its true value because of the idiosyncrasies of accounting.4 Investment Value The International Glossary defines investment value as “The value to a particular investor based on individual investment requirements and expectations”. when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.2 Fair Value “The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current transaction between willing parties.2. Hitchner (2003) 15 . depletion. 2003) or more directly. that is.” International Glossary of Business and Valuation Terms (International Glossary) (2001) 2. and amortization) and total liabilities as they appear on the balance sheet (synonymous with Shareholder's Equity). at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller.These standards of value are defined as follows: 2. & Schweihs.2. 2. expressed in terms of cash equivalents. acting at arm’s length in an open and unrestricted market.1 Market Value “The price. Reilly.2. the difference between total assets (net of accumulated depreciation. 2000) 2. “the term fair value is usually a legally created standard of value that applies to certain specific transactions” (Pratt. other than in a forced or liquidation sale” (Hitchner.2.

and cash flows. If intrinsic value is the actual worth of a company or an asset based on an 16 .” Given the dynamic nature of business. an auction setting is created in which each bidder is likely to offer a different price based on their individual outlook and the synergies that each bidder brings to the transaction. eg. dividends. dividends. assets. Graham et al (1988) states a general definition of intrinsic value would be “that value which is justified by the facts. based on an evaluation of available facts … It is an analytical judgment of value based on perceived characteristics inherent to the investment”. For companies and various investment alternatives (such as bonds).adds that investment value is the value to a particular investor which reflects the particular and specific attributes of that investor. the primary objective is to emphasize the distinction between “value and current market price but not to invest ‘value’ with an aura of permanence”. 2. The concept of intrinsic value is the actual worth of a security. patents and other intangibles that are difficult for investors to quantify. including the factor of management.5 Intrinsic Value Hitchner (2003) defines intrinsic value as the “amount an investor considers to be the ‘true’ or ‘real’ worth of an item. their value is intrinsic because it is generated by the underlying operations of the enterprise in the form of earnings. as opposed to its market or book value and so on.2.. In that case. For example. value is measured by its assessed qualities or by the esteem in which it is held. intrinsic value may differ from market value because of brand names. earning. In the case of a stock exchange. definite prospects.

Dodd.underlying perception of its true value. they tend to increase stock prices to levels above intrinsic value upon hearing good news.. then what are the measurable qualities that create value for a company? There are various approaches but no standard formula exists for calculating the intrinsic value of an asset. Murray. individuals are still responsible for most major investment decisions. Certain aspects of investing lend themselves to the scientific approach but . This is not a realistic tenet. & Block. investors tend to fall prey to their emotions and as a group may decrease a stock price below intrinsic value when bad news reaches them.. As a result. and the judgment factor still dominates investment decisions. how does that affect the way in which a business is valued? 2. for the This can be better summarized by Benjamin security analyst. As value can vary from individual to individual due to differing perceptions. in terms of both tangible and intangible factors. 17 . corporations are still business enterprises subject to the vagaries of human management and operate in highly dynamic and competitive environments. like medicine. Graham who said: “Investing.” (Graham. including all aspects of the business. the fact remains that for the foreseeable future. 1988) The efficient market theory states that since the stock market is so quick to adjust to new information security prices very quickly represent all the information available.3 Valuation objective: Why value companies? While computers can run simulations and compute numerous mathematical investment models. Cottle. law and economics. Conversely. lies somewhere between an art and a science. the number of variables remains almost infinite.

“Valuation rests on assumptions. A buyer must decide on a fair value before making a bid and a seller must determine whether the bid is a reasonable value before deciding to accept or reject the offer. human behavior cannot be modeled with mathematics. It underpins a major proportion of financial decisions in 18 . million dollars in their financials. By definition. failing to realize however that most companies round to the nearest thousand and in some cases. They see numbers and think of math. it is that there are too many. the buyer thinks the stock is worth having and the seller does not.1 Valuation is not an exact science. It cannot be calculated. The uncertainty will always be there.” (King. 2010) King (2010) continues stating that readers of financial statements expect exact answers. why are they performed? In short. The problem in valuation is not that there are not enough models for valuations. an exact science. There is no computer model that can predict whether someone will buy or sell their securities or at what price. Every time there is a trade of stock. the choice of assumptions in a valuation report requires the professional judgment of the valuator… The value can be higher or lower if certain critical assumptions are changed. This leads to the dilemma of which model(s) to use.3.As such. This can be summed up in the English expression “one man’s trash is another man’s treasure”. because valuation matters. So the question becomes. Risk and reward are beyond the intellectual limits of a computer. if valuations are not exact. 2. Valuation has many subjective factors which lead to many differences of opinion. there is a difference of opinion.

however. Dodd. price dictates an investor’s view of worth.2 Bargains and Value Studies of market efficiencies. the market’s pricing mechanism. “The Graham and Dodd approach. Valuations enable investors and executives to make more informed decisions regarding the use of capital.. sell or hold. Cottle. is too efficient to afford opportunities even for some investors to earn superior returns from security portfolios. and the insights from financial economics argue that for all investors or for the average investor there are no consistent returns to be earned from security analysis. & Block. (1988) advocate that security analysis and valuation does not seek to determine exactly what is the intrinsic value of a given security.g. failure to properly understand the position and worth of a business risks financial exposure for a wide range of stakeholders. to protect a bond or to justify a stock purchase) or else that the value is considerably higher or considerably lower than the market price.mature economies. modern portfolio theory.3. (Graham.” (Graham. From mergers and acquisitions to institutional investors. Graham et al. to buy. This comparison can then be used to base an investment decision. 2. Murray. takes the view that the market’s pricing mechanism remains based to such a degree upon faulty and frequently irrational analytical processes that the price of a security only occasionally coincides with the intrinsic value around which it tends to fluctuate. Without an assessment of value.. 2003) Supposedly. 1988) 19 . It needs only to establish either that the value is adequate (e. fueled by the efforts of capable analysts. An estimated value creates a reference point in which to compare with price.

2003. But can businesses (or a part ownership of those businesses) be bought at a bargain price? Proponents of the Efficient Market Hypothesis (EMH) would say “no”. then bargains can be found. investors can achieve above-average returns while taking below-average risks. Lokey and Masson. King. Most people are bargain hunters. Their behavior in the stock market appears to be the opposite. 2010. What we mean when we use this phrase is paying less for something than we think it is worth. But over the long term. Value is what we get. At the core of its success is the recurrent mispricing of securities in the marketplace. 1994). it is difficult to know if the investment is a bargain. investors are afraid to enter the market. Nielsen and Hudson. Benjamin Graham – often referred to as the father of “value investing” and followers of his teachings would say “yes”. 1987. 1987. 2. and Damodaran. In the short run. 1988. and the price is what we pay. When share prices fall. share prices converge with intrinsic value. they buy more. Thavikulwat. the market prices of good companies can go down and bad companies can go up. The general consensus among authors is that three general categories exist to value companies. Hitchner.4 Valuation methods: How can companies be valued? There is a substantial body of literature discussing different methods applied to valuation (Graham et al.. predicated on the proposition that the efficient-market hypothesis is frequently wrong. When we use this everyday expression we are distinguishing between the concept of value and price. we talk about “getting value for money”. Without knowing the value of a business. By finding securities whose prices depart increasingly from underlying value. If there is a discrepancy between price and value. in effect. These categories 20 .In everyday life. Value investing is. 2004. When their favourite grocery items go on sale.

the determinants of stock price are the expected cash flows from the stock and the required rate of return commensurate with the cash flows' riskiness. The following are a selection of the various valuation methods grouped and defined. including pros and cons of each method. comparable sales in the market (market) or replacement costs (asset):    Income Approach Market Approach Asset Approach Each of the above approaches has a variety of methods that can be independently applied to valuation. (2005) examined analysts reports issued during 19971999. 1987) According to this standard stock valuation model. (Nielsen & Hudson.are based on future economic use / earnings (income).4. They document that 99. It works by discounting through the use of an appropriate rate. the estimated future earnings (net cash flows) for a specific number of years. However.8 percent claim to use some variation of discounted cash flow and only seven of all reports use the price-earnings to growth ratio as their valuation method. 2. Researchers can only choose a method that has the least amount of drawbacks for the study’s particular situation. 21 . 12.1 percent of analysts mention the use of some kind of earnings multiples. no one of them is perfect.1 Income Approach The income approach is typically calculated using the discounted future-earnings method or a derivative of such. Asquith et al.

there are a potentially large amount of earnings that are retained. “If a company doesn’t pay all of its earnings out as a dividend. Barker (1999) and Asquith et al. However. The problem for this type of valuation is that it deals with the future. (2005) suggests that analysts' earnings forecasts.” 22 . (2005). and the Gordon Growth Model despite which each has its own flaws and disadvantages. adjusting down its payout ratio at the same time. and can continue to retain and compound these earnings. The predominant use of earnings forecasts in valuing stocks as documented by Bradshaw (2002) and Asquith et al. Analysts make forecasts on earning. valuations and stock recommendations are potentially flawed. The prevalent use of these methods has been documented by Bradshaw (2002). But the DDM doesn’t value these retained earnings. The present value of the cash flows and hence the stock price is a function of the analyst’s expectations of the future. Since the analysts' primary role is to advise investors on whether a stock is undervalued or overvalued. those retained earnings may be worth significantly more than the dividends. cash flows and growth rates and ultimately issue a stock recommendation or a target price that reflects their opinions about the investment value of the company. the future is unknowable and therefore any value derived from these models is pure estimation. and the DDM doesn’t recognise this. Discounted Dividend Growth model. Montgomery (2010) illustrates a further flaw in the Dividend Discount Model (DDM) and its derivatives. recommendations should be related to their valuations relative to current stock prices. And if a company can generate high returns on those retained earnings.Currently popular methods used by analysts include Discounted Cash Flow (DCF) method.

4. There are some drawbacks to this approach. Most important assumptions that were made in purchasing a comparable company are hidden. they are often a firm's 5 Such as. (2) fixed assets. it uses actual data.2 Market Approach The comparable sales approach focuses on sales of similar businesses in arm's-length transactions (Lokey & Masson. it is possible to examine the transactions in publicly traded companies. Data concerning sales of comparable companies is often scarce. or alternatively. it should be possible to establish the value foreign banks assigned to each bank however. Given foreign banks ownership stakes and based on the price paid for buyer’s stakes in Chinese banks. 23 . nonetheless. 1987). the amount to be received upon liquidation (Lokey & Masson. (3) personnel and (4) goodwill and other intangible assets. 1987). Also. such as the buyer’s expectations of growth in sales or earnings. not estimates based on a number of assumptions or judgments. 1987) While employees are not capitalized on the balance sheet. this will not account for any special agreements5 that may be involved.4.3 Asset Approach The asset approach focuses on the assets of the business and the cost to replicate the business. (Nielsen & Hudson. strategic alliances or joint ventures in the credit card business and so forth. such as if there are no similar companies or no recent transactions to compare to.2. It also lacks flexibility to include unique operating characteristics of the firm in the price paid for that stake. 2. Hitchner (2003) outlines some of the advantages of this approach is it is simple to understand and apply. Some other disadvantages of this approach include a lack of transparency in a transaction. The assets of a company are typically comprised of: 1) current assets.

Warren Buffett gave a speech at the Columbia Business School challenging the idea that equity markets are efficient. he remains rarely cited within traditional academia. The value of goodwill and any agreement not to compete6. he has never detailed his exact method of valuing a company and determining whether it An agreement not to compete is a common provision in a contract for sale of a business in which the seller agrees not to compete in the same business for a period of years or in the geographic area. While he is considered one of the most successful investors in the world. the researcher will not include this aspect in the study. the asset approach determines value on a two-step basis: 1. 6 24 . goodwill and any agreement not to compete. (1987) states that. Neisen et al. 1984). The second step is more difficult to determine and given the subjective nature of evaluating the value of goodwill and agreements. What is most striking is that Warren Buffett is inarguably one of.most important asset therefore employee evaluation is a major part of the quality factors to be considered when evaluating a company. and. The value of the assets (current and fixed) other than cash.5 The World’s Most Successful Investor In 1984. 2. Dozens of books have been written over the years that analyze Warren Buffett’s investment style. He debated against Michael Jensen a proponent for the “random walk” and Efficient Market Hypothesis (EMH). 2. most successful investors in the world and yet. if not the. Despite his argument and presented evidence (Buffett. nothing further was researched and it seems Warren Buffett’s achievements as an investor have been dismissed as an “accident” or “fluke” in academia.

The second table presented by Montgomery (2010) is 25 . In his paper. with its emphasis on value. his annual chairman’s letters contain great insight into his investment philosophy. the capital asset pricing model or covariance in returns among securities.1 Fundamental Analysis According to Dodd (1988). Buffett (1984) states that "Graham and Dodd investors … do not discuss beta. They simply focus on two variables: price and value. (1988) describes fundamental analysis as “A method of evaluating a security that entails attempting to measure its intrinsic value by examining related economic.” 2.5. Warren Buffett is often quoted as saying he considers himself to be 85% Benjamin Graham.2 contained in the appendix). and 15% Philip Fisher. financial and other qualitative and quantitative factors. is based on the principles of fundamental analysis. Graham et al. applying to a company that pays out all earnings as dividends.” 2.2 Value. The Superinvestors of Graham-andDoddsville.5. Few books have been able to figure out what Warren Buffett’s real “secret formula” of investing is.able”.has a sufficient margin of safety.able While Warren Buffett has never revealed his formula for valuing a company. Montgomery asserts that the basic arithmetic used in the first table is consistent with a discussion of valuation that Buffet published in his 1981 Chairman’s letter to Berkshire Hathaway shareholders. In Roger Montgomery’s book “Value. The Graham and Dodd concept of security analysis.1 and 2. in an era of acquisitions. leveraged buyouts and restructurings an intense analytical effort is required to determine the value of companies. Montgomery (2010) discusses two methods derived from Buffett’s writings and presents two valuation tables (reproduced in Tables 2.

however. While this approach also has flaws. These methods will be applied to the Chinese banks chosen for this study that are listed in China’s developing securities market. 26 . H1: There is a large discrepancy between the listed market price and the intrinsic value of Chinese banks.derived from the formula suggested by Richard Simmons’ book. the approach is simple to apply and will generate an additional figure to the spectrum of values. which applies to a company that retains all earnings. they provide a practical approach to valuation. Applied together. this study aims to expand the field of practical valuation by applying a range of existing valuation methods in conjunction with the newly proposed valuation of Montgomery (2010). This study hypothesizes that the speculative nature of China’s security markets contributes to the under and overvaluation of listed companies. H2: Non-state-owned banks will have an intrinsic value closer to their listed market price when compared with state-owned banks. the formulae are incomplete. such as need for stable economic data as the model assumes a static return on equity.6 Hypothesis Based on a review of the literature. In other words. state ownership negatively affects the intrinsic value of listed companies. Montgomery (2010) states that individually. 2. “Buffett step-by-step: an investor’s workbook – learn to analyze and apply the techniques of the master investor”.

The following chapter details the methods that were applied for calculating the spectrum of values and the Chinese banks to be tested in this research. 27 .

III. and this paper. using data from the balance sheet. is bound by realistic limits. therefore. This spectrum will then be compared with current market price of each bank. confining itself to a situation where the amount of data is small yet its significance indefinite. I hope to produce from these disparate sources a synthesis that draws reliable conclusions when possible and. Therefore. Given Warren Buffett’s success as an investor. Research Methodology 3. marks those areas that invite further research. 28 . using data gathered from foreign ownership purchases of Chinese banks are only useful as a starting point and were used to establish a baseline for the value range. An analysis of the Chinese banks is a research area where quantitative data are difficult to interpret. Montgomery’s adaptation derived from Warren Buffet’s use of the Graham and Dodd approach shall be used for the purpose of this study. when they are available at all. and the market approach. The methodology adopted in this paper is eclectic. Financial data are often incomplete or unclear. The asset approach. when not possible. The valuation approach proposed by Montgomery (2010) will then be applied to expand the spectrum of values for each bank. a careful consideration of the two approaches proposed by Montgomery (2010) is required.1 Introduction The objective of this research is to examine valuation results of different approaches in comparison to listed market prices of the selected Chinese banks in order to test the research hypotheses.

liabilities. attempts were made to source from appropriate financial databases7. Bank of China. China Construction Bank. CITIC Bank. Bank of Communications. with these limitations. China Merchants Bank and Shanghai Pudong Development Bank. The reason for establishing the stock price on December 31st is to establish an appropriate comparison of the year end share price with the intrinsic value formulated from financial data as of December 31st. The prices of relevant stocks were extracted from the Shanghai Stock Exchange for the target banks as of December 31st for each relevant financial year. Industrial and Commercial Bank of China and four non-stateowned banks. These banks consist of the “Big Four” state-owned banks. If annual reports or financial data were unavailable. It is unlikely that all historical stock prices can be extracted. earnings and other relevant financial data were extracted and calculated from firms’ annual reports for the year 2010 and for as many years prior as available.3. Agricultural Bank of China. the data is to be collected. Reuters. various financial data is limited. Thompsons and Morningstar 29 . 7 For example. Firms’ data on total assets. Therefore.2 Sampling and Data Collection A total of 8 banks listed on the Shanghai Stock Exchange were analyzed. such as the Agricultural Bank of China only publically listing in recent years. tested and analyzed according to the approaches outlined in this chapter. Due to some banks.

3. As such.3.1 Estimating Target Bank’s Value Using the Asset Approach In the asset approach. In order for ease of comparison of price paid per share.3 Valuation Models 3.2 Estimating Target Bank’s Value Using the Market approach The researcher examined foreign ownership stakes in each target bank and based on what they were paid in each corporate acquisition. This determines the approximate net worth of the company. 3.3. the Return on Equity (ROE) ratio is selected as a measure of the earning power of a business. Browne (2007) suggests that most of the time. It is important to note that debt can adversely affect this ratio. established an estimate of the value foreign strategic investors assigned to each bank. For the purpose of this study. such values are close to real worth at the time of the transaction.3 Estimating Target Bank’s Value Using the Montgomery Method Montgomery (2010) stresses that one of the most important factors in identifying the value of a business is its ability to generate profits. 30 . the value of the target bank is estimated from subtracting all liabilities from total assets to derive the value of the equity of the bank. this final equity amount was divided by the total shares to create an equity per share amount. Return on equity is calculated by dividing the net profit after tax (NPAT) of the company by the average of equity for the last year and current equity. These figures were extracted from the banks’ balance sheets and statements of cash flow.3.3. This is because return on equity is an indicator of profitability and an “essential ingredient in establishing the economic performance of the business”. it is assumed that accounting book value is an accurate representation of an asset’s value.

2 by one minus the payout ratio. For the purpose of this study. the extracted market prices were compared to the value range. overvalues or falls within the range of values for each target bank. The researcher will then use these two figures in both Tables 2.1 by the payout ratio8. This value range was then compared to the yearly market price of the listed banks as of December 31st.4 Analysis The results from each approach were combined to establish a spectrum of values for each target bank.1 Hypothesis Testing For each target bank. Second multiply the result obtained from using Table 2.4. 3. to determine the appropriate multiplier to apply to each banks’ equity per share. the researcher will adopt an after-tax investor’s required return of 10% as suggested for illustrative purposes by Montgomery (2010).2. This is in 8 Calculated as Dividends per Share divided by Earnings per Share.1 and 2. 31 . a required rate of return must also be established. 2) if the bank were to retain all earnings.Once the ROE has been established. multiply the result obtained from using Table 2. If the target price falls outside the value range. Montgomery (2010) states that in the real world. First. This will give two figures corresponding to two valuation scenarios 1) if the bank were to pay out 100 per cent of their earnings as dividends. The addition of the two results will arrive at an estimated intrinsic value for the bank. His proposed solution is to do the following. 3. The objective is to determine if the listed market price undervalues. then further analysis should be done to determine if a large discrepancy exists. most businesses payout a significant proportion of their earnings and thus fall between the two examples.

This is in line with the research objective of comparing state-owned banks intrinsic value and market price and that of the non-state-owned. This was examined in light of the first hypothesis. This was examined in light of the second hypothesis 32 . The research will also evaluate the proximity of the non-state-owned banks’ intrinsic value to their listed market price in comparison to that of the state-owned banks.line with the objectives of the research to determine if a large discrepancy exists between intrinsic value and market price.

2 Descriptive Statistics: Asset Approach This section describes the data collected for the Asset Approach.1 Introduction This chapter presents the results of the research. This chapter then discusses the comparisons of the market prices of the Chinese banks with the results of each valuation method to determine which bank’s price lie within or outside the value range.2. 33 . Results of the Comparison 4. 4. The data is collected from companies’ annual reports obtained from the investor relations section of each banks’ websites. The annual reports studied in this research are for the financial data of the year 2010 and for as many years prior as available. The chapter ends with the results of the hypotheses being tested and the summary of the findings. 4. in this research.IV. This is followed by the descriptive statistics of the Market Approach data collected and the next section presents the descriptive statistics of the data sample using the proposed Montgomery Method. The total number of banks studied is eight. The first section discusses the descriptive statistics of Asset Approach data collected.1 Non-State-Owned Banks The following tables illustrate the total asset and liability data collected for the non-stateowned banks.

682.444          1.1 illustrates the net worth of the Bank of Communications as increasing annually. the base value range of the Bank of Communications is 3. 2010.137          2.02  0.144.988            1.253          129.319.095        133.190.936  3.19 RMB.82  1.146           52.309. the base value range of the CITIC Bank is 3.14  Table 4.123             1.495          83.011.293           1.776.425        150.98 RMB.2 illustrates the net worth of the CITIC Bank as increasing annually.423.023                1.723                594.36  3.951. As of December 31st.377  Remaining Equity Equity Per Share          124.947          2.977.095                    675.2.593          3.06  2.2.439          1.340.314            1.029                    571.956.144.15  1.902       223.98  3.31  2.005  Total Liabilities Remaining  Equity             3.852             1.321           90.602   Total Liabilities                1. 34 .98  1.657        164.668.081.196                    927.103  Equity  Share  Per  3.712            2.72  1. Table 0-2 CITIC Bank CITIC Bank  2010  2009  2008  2007  2006  2005  Total Assets           2.091. 2010.776                1.628.570            1.538          108.110.77  3.374           84.1-1 Bank of Communications Bank  of  Total Assets  Communication  2010  2009  2008  2007  2006  2005  2004              3. As of December 31st.Table 4.694            23.532.091            31.276            1.19  2.186                706.719.75  Table 4.483          1.2.225  3.727.

926  81.589 Equity Per Share   2.087 41.59  7.20  2.411  1.980  689.07  2.624 109.62  6.76  35 .776 3.908 8.022 359.554.280 68.42  4.Table 0-3 China Merchants Bank Merchants  Bank  2010  2009  2008  2007  2006  2005  Total Assets  Total Liabilities  Remaining  Equity  134006 92783 79781 68396 55160 25998 Equity Per Share   2402507  2067941  1571797  1310964  934102  734613  2268501 1975158 1492016 1242568 878942 708615 6.638 557.434 81.523  455.425  914.969 13.496  Total Liabilities  Remaining  Equity  123.510 12.37  6.255 13.298 24.394 7.068.08  3.724 886.99  3.553 442.50  6.622.267.691  111.75  2.702 28.718  1.358  573.25  4. As of December 31st.046 271.191.71  7.21RMB. the base value range of the China Merchants Bank is 6.210  84.960 7.057  279.3 illustrates the net worth of the China Merchants Bank as increasing annually until 2008 where there was a decline.51  Table 4.067 2.309.131 1.340 166.93  0.21  4.2.197 95.671 67.45  3. 2010.631 1.301  173.591  103.85  5.532  371.011 7.682 664.65  3.720 15.23  1. Table 0-4 Shanghai Pudong Development Bank Pudong  Development  Bank  2010  2009  2008  2007  2006  2005  2004  2003  2002  2001  2000  1999  1998  1997  Total  Assets  2.

67  1.539. As of December 31st.42 2.32  1. 2010.406  8. This was rectified prior to the IPO with the assistance of the Chinese Government 9 . the bank had a severe problem with Non Performing Loans (NPLs) which lead to liabilities greater than the assets of the bank creating a negative equity figure.78 1.337. In the case of the Agricultural Bank of China.170 8.93 1. Prior to publicly listing.033. the Great Wall AMC was created. 4. one for each of the four commercial state-owned banks to purchase Non-Performing Loans and thereby improve the banks’ balance sheets prior to publicly listing.2. As of December 31st.882.014.59.2. 9 36 .63 1.663 6.Table 4.2-1 Agricultural Bank of China Agricultural  Bank of  China  2010  2009  2008  2007  Total Assets  Total Liabilities  Remaining  Equity  542236 342925 290541 ‐727605 Equity Per Share   10.2.4 illustrates the net worth of the Shanghai Pudong Development Bank as initially decreasing then a turnaround to increasing annually from 2001.12  ‐2.506  9. the base value range of the Shanghai Pudong Development Bank is 8.305.111 1.351  5. 2010.22 1.25 The Ministry of Finance of the People's Republic of China established four financial asset management corporations (AMCs).2.795. the base value range of the Agricultural Bank of China is 1.67RMB. Table 4.2-2 Bank of China Bank of China  Total Assets  Total Liabilities  Remaining Equity Equity Per Share   2010 2009 2008 2007 2006 2005 2004 10459865 8748177 6951680 5991217 5327653 4740048 4270443 9783715 8206549 6461793 5540560 4914697 4484529 4037705 676150 541628 489887 450657 412956 255519 232738 2.5 illustrates the net worth of the Agricultural Bank of China as increasing annually.723.2.588  7.2 State-Owned Banks Table 4.810 6.13 1.80  Table 4.

Table 4.6 illustrates the net worth of the Bank of China as increasing annually.82  1.2.751  6.458.41  1. 2010. the base value range of the China Construction Bank is 2.369 2. As of December 31st.119 9.456.934           606.045) Equity Per Share   2010  2009  2008  2007  2006  2005  2004  13.516 8.28  1.42RMB.2.636.00  1.Table 4.35  2.2.05  Table 4. prior to publicly listing ICBC had a severe problem with Non Performing Loans (NPLs) which lead to liabilities 37 . As with the Agricultural Bank of China.2-3 China Construction Bank Construction  Total Assets  Bank  Total Liabilities  Remaining  Equity  Equity Per Share   2010  2009  2008  2007  2006  2005  2004  10810317  9623355  7555452  6598177  5448511  4585742  3909920  10109412 9064335 7087890 6175896 5118307 4298065 3714369 700905 559020 467562 422281 330204 287677 195551 2.2.146  8.037.2.01  Table 4.630           543. 2010.676           471.03  1.577.750 6.508.140.785.324  12. Table 4.63  1.683.39  2.47  1.001           259.80  2.036 7.106.255 5. the base value range of the Bank of China is 2.965 11.150.131  5.80RMB.81  1. As of December 31st.757.7 illustrates the net worth of the China Construction Bank as increasing annually.069.876        (508.622  11.8 illustrates the net worth of the Industrial and Commercial Bank of China as increasing annually.2-4 Industrial and Commercial Bank of China ICBC  Total Assets  Total Liabilities  Remaining  Equity  821657          678.712  7.053  9.196.05  ‐2.

attempts have been made to discover the price paid at the time of transaction.49 times the 10 The Huarong AMC was created to handle assume the non-performing assets.greater than the assets of the bank creating a negative equity figure.35RMB. such as a strategic partnership or strategic investment. As of December 31st.9% of the Bank of Communications.86 RMB per share. This was rectified prior to the IPO with the assistance of the Chinese Government10.77 billion shares in the bank purchased for 1.1 Non-State-Owned Bank of Communications HSBC is the sole strategic investor in the Bank of Communications. As of January 2005. 4. 38 .3. primarily NPLs of ICBC. HSBC held 7. the base value range of the Industrial and Commercial Bank of China is 2. 2010.3 Descriptive Statistics: Market Approach This section describes the initial and subsequent public offering issue prices of the researched Chinese banks and the foreign ownership stakes each banks. 4. Where a substantial ownership stake is found. As mentioned previously. Another potential flaw is that many foreign ownership transactions occurred in the Hong Kong Stock Exchange and not the Shanghai Stock Exchange so exchange rate conversions must be made which may distort the value figure. HSBC purchased an ownership stake of 19. It also lacks flexibility to include unique operating characteristics of the firm in the value it produces. one of the disadvantages of this approach includes a lack of transparency in a transaction. 1. such as their expectations of growth in sales or earnings. Most of the important assumptions that strategic investors made in purchasing and divestment of their holdings are hidden.

This was approximately a 40% discount to the IPO issue price of 5. and closed at HK$5. It dropped below the IPO price. In June 2010. Red chips are therefore separately incorporated in Hong Kong in order to allow foreign investment in Chinese companies. 39 . only Chinese citizens are allowed to invest on Chinese stock exchanges. Generally speaking.00RMB to 5.80RMB. CITIC Bank In 2007.86. it has performed the poorest among the all “Red Chip”11 financial stocks.802. HK$5.80 RMB each. 11 A stock in a company operating in the People's Republic of China that trades on the Hong Kong Stock Exchange. (Ku. which is the official color of the Communist party. The term refers to the color red.9% stake.75 times its 2007 book value from 2. HSBC has yet to divest any shares.180 million thereby maintaining HSBCs 19. CITIC Bank was forced to lower its maximum issue price to 2.06-HK$5.80.81 times as mainland institutional investors and regulators deemed the valuation too rich.79 on 5 June 2007. The transaction represented a consideration of approximately HK$7.14 per share ( approximately 4. The IPO value range was set at HK$5.83% of CITIC shares at 3.company's stated 2004 book value and at a slight premium to the value of the equity per share. The shares were issued pursuant to the anti-dilution rights and top up rights. a Spanish based banking group negotiated to be CITIC bank’s sole strategic investor and purchased 4. HSBC agreed to subscribe to Bank of Communications new rights issue for 1.48RMB per share).396. According to Reuters. while the range for the Shanghai-listed shares was set between 5. Banco Bilbao Vizcaya Argentaria SA (BBVA).037 H-rights shares at HK$5. Since the bank has been listed in the Hong Kong Stock Exchange.42RMB per share. 2007).

3 RMB of its A shares listed on the Shanghai Stock Exchange at the time of announcement. There are two foreign ownership stakes in China Merchants Bank.880675 CNY) 14 Approximately 8. The option was executed at HKD 6. up to 10. (Jianxin & Master.45 per share13. China Merchants Bank does not have a strategic investor relationship with either foreign owners. 2010) China Merchants Bank set an A-share rights issue price of 8. China Merchants Bank China Merchants Bank initial public offering was 1. first. neither has holdings of over 5% of total shares.55 per share14.86RMB based on 2009 HKD to RMB exchange rate 22 day average(1 HKD = 0. 12 13 By exercising its share option from a Share and Option Agreement entered into on 22 November 2006. and up to 15%12 later with the transaction closing on April 1st. Approximately 5. However. The Hong Kong IPO issued 2. a price comparable to that of the initial IPO price. 40 .42RMB per share based on September 2006 average exchange rate.85 RMB per share compared with a closing price of 16.30RMB per share on Shanghai Stock Exchange on 27 March 2002.07% on February 2009. 2010. The largest is JPMorgan Chase holding approximately 452 million shares. BBVA increased its shareholding in the Bank on two consecutive occasions up to 15% of total shares.2 billion overseas listed foreign currency denominated shares (H shares) on 22 September 2006 at HK$8.5 billion common shares in RMB (A Shares) at an issue price of 7. Both ownerships trade predominantly in the Hong Kong Exchange and appear to have no invested commitment to the bank.In 2009. The second is Blackrock. Inc holding 265 million shares. In March 2010.

32RMB per share). It has held several capital raisings since this initial IPO. A decade after going public. On 23 December 2002.39%. Citibank Overseas Investment Co.59RMB per share. the Company issued additional A share 300 million shares with an issue price of 8.Shanghai Pudong Development Bank On September 23.45RMB for each share. Every Apr. the bank issued a further 904 million non-publicly offered A shares with an issue price of 16.9 percent.000 ordinary shares (Share A) to general public in China with issue price of 10. Citibank originally invested 600 million yuan to buy the five-percent stake in SPDB (approximately 3. Ltd and Shanghai's Jiushi Company and SPDB non-circulating shares.3. However.64       16.00RMB for each share. has held a stake of approximately 5% of the total share capital of the bank. 41 . 2002  November. Citigroup has not raised its ownership stake and in 2006 reduced it slightly to 3.45       13. taking its stake in SPDB up to 24.  1999  December. SPDB implemented a profit distribution plan of 4 bonus shares for every 10 shares during the period and Citibank's percentage holding was further reduced to 3. on September 18.1-1 Summary of SPDB New Shares Issue Prices Year  September. Table 4. 2006  September. 2009.00         8. Citibank had the option to buy SPDB shares from Shanghai State Assets Managing Co..78%.64RMB for each.000. 2009  Price (RMB)     10. 2006. In 2008. 1999 the Shanghai Pudong Development Bank (SPDB) issued 400. On November 16.59   Since 2003. 30 from 2006 to 2008. the bank issued additional A share 700 million shares with an issue price of 13.

it is unknown if Standard Chartered has call options or other opportunities to increase its stake at a later date.4. Bank of China In 2005. This holding is only 0. The consideration was financed from Standard Chartered’s internal cash resources and was for the number of shares with a total value at the offer price of the Hong Kong dollars equivalent of US$500 million. UBS AG held 3. approximately. UBS AG (UBS) and the Asian Development Bank (ADB).37% of the total shares however due to the recent timing of the IPO.2419% of the 15 It should be noted that the parent company of AFH is Temasek Holdings. Standard Chartered Bank invested US$500 million as a cornerstone investor in Agricultural Bank of China Limited’s H-Share Initial Public Offering (IPO) in Hong Kong. 2010.6129% equity and the ADB held 506.679. Ltd15. (AFH).68 RMB offer price is considered for the value range of the Agricultural Bank of China. the equivalent 2.471.102 shares. an investment company wholly owned by the government of Singapore.860. As Standard Chartered paid the HKD offer price.3.236 shares. RBS held 20. The two banks signed an agreement to develop new business opportunities together. accounting for 10% of the Bank's total equities. 0. the Bank of China entered into separate agreements and established strategic partnerships with the Royal Bank of Scotland Group and its wholly owned RBS banks and controlled RBS China (together “RBS”).368. According to the Bank of China's 2005 annual report.377.118 shares or 5% total equity.736. 42 .2 State-Owned Agricultural Bank of China In June.942.684 shares or about 1. Asia Financial Holdings Pte. by the end of 2005. AFH held 10.

RBS' contractual commitment to retain the 4. According to UBS 2008 Annual Report. made an 16 Approximately 1. 2005.55RMB per share 43 .519 million). the Bank entered into strategic investment and cooperation agreements with Bank of America Corporation (‘‘Bank of America’’) on 17 June 2005. and an investment agreement with Asia Financial Holdings Pte. The listed IPO issue price was 3.Bank's total equities. The Bank issued ordinary shares to each strategic investor at 1RMB per share.08RMB per share. China Construction Bank According to China Construction Bank’s 2005 Annual Report. Bank of America committed to purchase approximately nine percent of the stock of China Construction Bank (CCB) for $3.5 billion in August 2005 and during CCB’s initial public offering in October 2005.4 billion.4 billion Bank of China Limited H-shares to institutional investors for a cash consideration of approximately CHF 887 million (HKD 6.70RMB. According the RBS 2009 Annual Report the 4.93HKD or about 1. in December 2008. 2009.26% investment in Bank of China was sold for HKD 18. on 1 July 2005. (‘‘AFH’’). on June 17. On January 7th and 14th. According to Bank of America’s 2005 Annual Report. UBS disposed of its equity stake in Bank of China through a placing of approximately 3.7116 per share.0 billion. The initial purchase of CCB shares for $2.26% Bank of China (BoC) stake ended on 31 December 2008. approximately HK$1. The sale values each share at approximately 1. RBS divested by sale or transfer its entire stake in Bank of China. Ltd.

on 25 September 2007.additional purchase of $500 million. it is calculated that initial purchase of CCB shares was between 0. The other significant foreign shareholder of CCB is Temasek who now holds its shares in the investment vehicle Fullerton Financial. approximately 4.580. Bank of America exercised its call options in July and November 2008. The details of their purchase conditions are not publicly available. 17 18 Allowing for fluctuations in exchange rates dating back to the dates of the IPO. Later in 2009.8 billion.6 billion common shares for approximately $9.1 billion common shares representing their entire initial investment in CCB for $10.35 per share (approximately 2.6 billion common shares of their initial investment in CCB for $2. State-owned holder of the majority of CCB’s ordinary shares. in accordance with the Share Purchase and Options Agreement signed by Huijin18 and Bank of America.000 H-shares and 19. for approximately 4.97RMB per share.2 billion paying approximately 2. 44 .153.84 and 0. a wholly owned subsidiary of Temasek Holdings. Bank of America sold 19.45RMB.38RMB per share.86RMB per share17 According to CCB’s 2008 Annual Report.25RMB per share).000.14RMB per share.1 billion. the Bank issued 9 billion A-shares in its domestic IPO at an issuance price of 6. They have not altered their ownership stake since the initial IPO. acquiring 6. As the float on the Hong Kong stock exchange had an issue price of HK$2. in 2008.000. In addition in January 2009. According to CCB and Bank of America’s 2008 Annual Reports. Bank of America sold 5.370 H-shares of the Bank respectively from Huijin purchasing 25.

86 a The National Social Security Fund (SSF) is a fund set up by the PRC government to provide social security for the nation’s aging population and to support economic development and social stability.7 million and USD 200 million. 6. On 29 June 2006.38 and 3.300.12 and HKD 3. 20 Between 3. Allianz continues to hold 3. Each investor paid 1.26RMB per share.216. According to the joint press release by Industrial and Commercial Bank of China (ICBC) and Allianz Group (Allianz) issued on March 25. 19 45 .623 shares newly issued by the Bank for a consideration of approximately RMB 18 billion. namely Goldman Sachs. at the end of their lock-up period. Allianz sold 3.392.276.432.014. On the same date. Allianz and American Express.508 H shares in ICBC.155 shares.601. the Bank entered into share purchase agreements with three foreign strategic investors.582. Goldman Sachs. SSF19 subscribed for 14.06 million shares also at HK$ 3. 2009.8167).216.300. or 1. to a select group of investors through a private sale for a sale price of 3.507 ICBC H shares.122. Industrial and Commercial Bank of China Limited was concurrently listed in Shanghai and Hong Kong. The offering prices for A-shares and Hshares were RMB 3. American Express also sold almost half of their ownership stake approximately 638. representing the shares that have become free from lock up on April 28. On 27 October 2006. Allianz and American Express subscribed for 16.07 per share.0304 and EUR 1 to RMB 9. EUR 824.015 shares and 1.476.233 shares newly issued by the Bank on 28 April 2006 for a consideration of USD 2.2 million.40RMB per share. 2009. respectively (on the basis of an agreed exchange rate of USD1 to RMB 8. The offering prices for A-shares and Hshares were essentially the same having taken currency conversion into account.Industrial and Commercial Bank of China On 27 January 2006.86 HKD per share20.26RMB per share.324.

According to the ICBC’s 2010 Annual Report. with the same basis adopted for the rights issue of A-shares and H-shares.9% to the closing price of RMB 4. while the subscription price per H rights share of HK$ 3. in November 2010. 4.49 represented a discount of approximately 47.4 Descriptive Statistics: Montgomery Method The following section outlines the estimated Intrinsic Value (IV) calculated using the Montgomery Method and is based on financial data. Goldman Sachs sold 3. the Bank implemented a rights issue of A shares and H shares. as of December 31st. At the end of September 2010. gathered from the banks’ annual reports.4% to the closing price of HK$6. the date on which the subscription price for the rights issue was determined).7421 each.49 per H rights share. The subscription prices were RMB 2.share through private sales. as of December 31st for each year.04 billion ICBC shares at HK$ 5. The rights issue was conducted on the basis of 0.01RMB per share 46 .99 represented a discount of approximately 36. The IV is then compared with the listed share price for each bank.63 per H share as quoted on SEHK on the price determination date.99 per A rights share and HK$ 3.45 rights shares for every 10 existing shares. The subscription price per A rights share of RMB 2.74 per A share as quoted on Shanghai Stock Exchange (SSE) on the price determination date (10 November 2010. 21 Approximately 5. which were the same after exchange rate adjustment.

30  16.80                21.56   9.24   4.1.53  8. One exception to this appears to be the Bank of Communications which has maintained a stable and steadily rising intrinsic value.89  18.81   ‐     1.49  12.04                 38.23                                                                 8. across the board all banks drastically increased net profits after tax (NPAT).78   16.80  12.53                 12. As with most global banks. the banks’ intrinsic values are generally rising over time and share price is decreasing.49   15.76                 21.15                                                                        3.74   4.52   ‐                                                                      2.75  16. Table 4.4. 22 23 HSBC’s financial data is reported in US dollars.23  2006  17.75   As shown in Table 4.25                                                               10.25  11.81                             14.39               21.35   3.11   ‐     Bank of  Communication  Merchants  Share  IV  Price                            24. This creates a reference benchmark of a non-Chinese bank.62   ‐     IV                29.06  2007  20.86  HSBC23  Share  Price  10.65  39.25                52.58  18.1-1 Comparison of Non-State-Owned Bank’s Montgomery Intrinsic Value Shanghai  Pudong  Development  Bank  IV  2010  5.87  2009  3.16                             22. the estimated intrinsic values of HSBC22 have been included in the following table.05                             29.21   5.46   3.4.36                               3.19  CITIC Bank  Share  IV  Share Price  IV  Price                                                              12.63                             6.02   9.4.47   10.69                13. In 2008.84  2008  5. This created a spike in intrinsic value for some banks however these increases were not sustained and hence intrinsic value dropped the following year.99   5.83   8. leading to a convergence between the two. it appears HSBC’s intrinsic value was impacted in the years of the GFC .62   ‐    1.4.1 Non-State-Owned For the purpose of comparison of non-state-owned banks with a long standing publicly listed bank.42   Share  Price               12.62   4.44  2005  18.07                 67.86                                                             6.31                  9.43                 10. 47 . It should be noted that the Chinese banks began with high share prices which fluctuated significantly.

33           2.19                 3.83                 9.59                 6.87  2009  3.86  2007  20.2-1 Comparison of State-Owned Bank’s Montgomery Intrinsic Value HSBC  IV  2010  5. the intrinsic value of the state-owned banks has risen every year and appears to be far more stable than that of the non-state-owned banks. the share price has moved to converge with estimated intrinsic value. Table 4.54   As shown in Table 4.2.26              ‐       3.4. 4.89   Share  Price                4. with the exception of the Agricultural Bank of China.54                     ‐        1.85   IV  ICBC  Share  Price           4.5 Market Price Comparison with Value Range The results from each approach were combined to establish a spectrum of values for each target bank.32   ‐    0. As with the non-state-owned banks.4.30  16. 24 HSBC’s financial data is reported in US dollars.84  2008  5.06  Agricultural  Bank of China  IV        4. the estimated intrinsic values of HSBC24 have been included in the following table.67   Share  Price          3.25  11.4.13            6.26             7.98         3.4.54            8.89  18.11              ‐       3.68         2.68             5. upon listing.43   China Construction  Bank  IV            8.23  2006  17. each bank had a share price well above that of the estimated intrinsic value.97           6.75  16. 48 .19  Share  Price  10.24            5.75      5.53  8. This value range was then compared to the yearly market price of the listed banks as of December 31st to determine if the market price falls within or outside the estimated value range.92              ‐       1.20                ‐        8.59             2.47                                2.44            3.61           5.23           4.99         0.70   Bank of China  IV     5.46      5.2 State-Owned For the purpose of comparison of state-owned banks with a long standing publicly listed bank.80             ‐               ‐     Share  Price        2.93             1. Over time.21      4.01              ‐       2.44  2005  18.66             3.43      3.

98  1.21 10.1 Non-State-Owned Table 4.31 2.46 4.72  1.02 8.86    3.74  15.1-1 Bank of Communications Bank of  Communications  2010 2009 2008 2007 2006 2005 ‐ Jan Pre‐IPO  2004 Asset  Market  Montgomery  Dec 31st  IV  Share Price  12. As of December 31st.83       3.25  8. 2010 the share price appears to be at a discount to its estimated intrinsic value.47 1.02 0.19 2.77 3.36  3. Table 4. 49 .48            1.4.86    The Bank of Communications share price falls within the established value range.06  2.14    5.5.83 4.24 6.62  6 Month  Average Share  Price  6. 2010 the share price appears to be at a discount to its estimated intrinsic value.5.86  10.42       The CITIC Bank share price falls within the established value range.1-2 CITIC Bank CITIC Bank  Asset  Market  Montgomery  Dec 31st Share  IV  Price  9.15 1. As of December 31st.81    2.11    5.99 3.62    1.5.01 10.15  2010 2009 2008 2007 2006 2005 3.70 7.23  3.87 11.14  4.75    5.56  9.35  4.98  3.49 3.82  1.52    1.

31  9.51                The China Merchants Bank share price has fluctuated greatly.63  16.86  15.53 12.78 3. other years within the established value range.1-4 Shanghai Pudong Development Bank Shanghai Pudong  Asset  Development Bank  2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 8.80 22.76 Market  Montgomery  Dec 31st Share  IV  Price  29. Table 4.00                       3.00  10.72 5.43 10.75  24.39  21.53  9.08 3.5.80  21.46 12.00  0.42 4.62 6.16  39.69  20.76 ‐8.75  0.25  52.5.31 2. 2010 the share price appears to be at a discount to its estimated intrinsic value.36  6.04 38.25 4.71 7.05  12.69  13.21 4.79 5.92 2. the share price is outside the valuation range.81  18.62    12.07 2.93 0.65 3.32                   50 .Table 4.85 5.60 1. Some years.58 29. As of December 31st.76 21.50 6.65 6.07 67.23 1.20 2.93 2.75 2.75  7.1-3 China Merchants Bank China Merchants  Bank  2010 2009 2008 2007 2006 2005 Asset  Market  Montgomery  Dec 31st Share  IV  Price  24.59 7.49 14.42 6.99 3.45 3.37 6.

68 4.80    2. As of December 31st.68  1. there is no longitudinal data for comparison.2-2 Bank of China Bank of China  Asset  Market  Montgomery  Dec 31st Share  IV  Price  5.5.42    2. However in the volatile years surrounding the GFC.26 3.00    3. the share price jumped and then it appears that intrinsic value has risen rapidly till the share price now falls with the value range.93 1.97  6. As of December 31st.08 1.98 3.25    1.22 1.12    ‐2.63 1.80    As the Agricultural Bank of China listed recently.01 2.13 1.67 3.23  4.43 3. the share price lay within the value range.70 3.55 1.33  2. 4.2 State-Owned Table 4. Initially. 2010 the share price appears to be at a discount to its estimated intrinsic value.92 1.99 0.43  2010 2009 2008 2007 2006 2005 2004 2. Initially.78    1.2-1 Agricultural Bank of China Agricultural Bank of  Asset  China  2010 2009 2008 2007 Market  Montgomery  Dec 31st Share  IV  Price  2.5. the Shanghai Pudong Development Bank share price has fluctuated greatly. 2010 the share price appears to be at a discount to its estimated intrinsic value. the share price lay outside the value range and over time decreased to converge with intrinsic value.47    0. Table 4.As with the China Merchants Bank.67 1.32    ‐0.5.32    1.61  5.00 51 .

01       5.59  6.40    1.93 1.11 2. however.80     2009 sale 2.54  8.85      The China Construction Bank share price was initially greater than the estimated intrinsic value range.35    Montgomery  Dec 31st Share  IV  Price  8.89    3.97 2007 1. Table 4.2-4 Industrial and Commercial Bank of China ICBC  Asset  Market  2.26    52 .5.41 1.47     2005 1.68 Dec 31st  Share  Price  4.00    3.38 ~ 3. As of December 31st.47   5.84 ~0.24  2010 Sept 2010 sale     2009 March 2009 sale     2008 2007 2006 2006 ‐ Pre IPO     2005 2004 2.The Bank of China share price has fluctuated less than that of the non-state-owned banks. Table 4.5.12 1.66 3.77 2010 2.21 4.44     5.26 7.38 January 2009 sale    4.54    1.83  9. the share price lay outside the valuation range.00  2. over time gradually converging to within the established value range.86RMB 5.13  6.75 5.25 June 2005 ‐ Pre IPO    0. 2010 the share price appears to be at a discount to its estimated intrinsic value. 2010 the share price appears to be at a discount to its estimated intrinsic value.19     6 Month  Average Share  Price  4.2-3 China Construction Bank China Construction  Bank  Asset  Market  Montgomery  IV  8.63 1. Initially.28  2.05 ‐2.54 0.85 6.39  4.03    3. As of December 31st.82    1.81     2006 1.14    2008 purchase 2.05    3.2  4.46 5.59 2. As with other banks it appears the share price gradually converges to within the established value range.

As with other banks it appears the share price gradually converges to within the established value range. in particular the Royal Bank of Scotland and Citibank. HSBC has maintained its ownership stake without divesting any shares. Economic performance of the Chinese banks may have been impacted in several ways by the global financial crisis. 4. However.9% and their ownership stake has been diluted by capital raisings. Citibank was seriously affected by the global financial crisis. 2010 the share price appears to be at a discount to its estimated intrinsic value.The Industrial and Commercial Bank of China share price was initially greater than the estimated intrinsic value range. this cannot be known for certain.6 Macro Economic Factors It is important to consider the macro-economic factors that may have influenced the results of this study. As of December 31st. Several of the Chinese banks strategic investors were also impacted. it is surprising that BBVA has increased their stake in CITIC Bank threefold. 53 . it is not surprising that they did not take advantage of their option to raise their stake in Shanghai Pudong Development Bank to 24. Bank of Communications appears to be the most stable of the non-state-owned banks and their strategic investor. However. the reasons for this are unknown. BBVA has a long term vision of cooperation with CITIC Bank. and so. The researcher posits that due to BBVA’s strategic aim to grow business within the Asian market and CITIC Bank’s strategic aim to grow their business in South America.

Similarly. Allianz. The results earlier indicate support of H1 for non-state-owned banks as shown in Figure 4.37%.6-1. the hypotheses stated for the research are tested. On the world scale. 2009 they sold their original stake at nearly four times the initial price paid. this may illustrate a lack of commitment to the holding. 4. The first hypothesis proposes that the speculative nature of China’s security markets contributes to the under and overvaluation of listed companies. as they took advantage of their call options to double their ownership stake in November of 2008 and then a few months later in January. UBS and RBS suffered severe financial losses during the GFC and in 2009.7 Results of Hypothesis Testing Based on the results. The state-owned 54 . its ownership stake is conspicuously small at 0. The volatility of the share price creates a large discrepancy between listed market price and estimated intrinsic values.While Standard Chartered has become a cornerstone investor in the Agricultural Bank of China. Bank of America seems to have profited the most. It is unknown if they would have maintained their ownership stakes without the consequences of the crisis on their financial standings. American Express and Goldman Sachs all chose to take profits and reduce their stake holdings in ICBC however they still retain approximately half their previous holdings. H1 states that there is a large discrepancy between the listed market price and the intrinsic value of Chinese banks. sold their complete stake in Bank of China in order to bolster their balance sheets. It remains to be seen whether the bank’s relationship will grow and develop into something more than a cornerstone investor. The second hypothesis proposes that the state ownership negatively affects the intrinsic value of listed companies.

Figure 4. the results do not appear to support this hypothesis.00  40. H2 states that non-state-owned banks will have an intrinsic value closer their listed market price when compared with state-owned banks. Possible explanations of these results will be discussed in the concluding chapter. As such.00  10.00  50. Therefore.00  30.00  ‐ 55 Estimated Intrinsic Value Maket Share Price .00  20.7-1 Comparative discrepancy between market price and intrinsic value of non-state-owned banks 60. The results suggest that the estimated intrinsic value of the state-owned banks has grown more stably and is closer to their listed market price compared with non-state-owned banks. for non-state-owned banks.00  ‐ 2005 2006 2007 2008 2009 2010 Merchants IV CITIC Bank IV Bank of Communication Share Price Merchants Share Price Bank of Communication IV Pudong IV CITIC Bank Share Price Pudong Share Price 50. H1 is supported.00  30.00  10.00  40.00  20. The results earlier indicate that the non-state-owned banks share price is far more volatile than that of the state-owned banks. the results indicate the discrepancy between the two is not large as shown in Figure 4.00  70.00  80.6-2.banks intrinsic values and listed market prices appear to be more stable and as such.00  60.

00  8.00  7.00  .00  4.00  1. (2006) that suggests direct competition among the largest banks is weak due to several factors.00  ‐ 2005 2006 2007 2008 2009 Bank of China IV ICBC IV Bank of China Share Price 2010 10. Second. China’s fast economic growth and.00  6.00  6. in particular the high investment rate. Foreign competition is limited to the wholesale business and in few areas.00  2.7-2 Comparative discrepancy between market price and intrinsic value of state-owned banks Market Share Price 8. First the price and quantity controls imposed by the government have not been fully lifted and the opening up to foreign competition has proceeded cautiously. This is in line with the finding of Garcia-Herrero. there is room for all the banks to make business.00  2.00  3. the important findings are summarized in this section. 56 Estimated Intrinsic Value 9. The fluctuations in performance indicated by the results suggests that non-state-owned banks appear to compete in a separate highly competitive market to that of the big four state-owned banks.8 Summary of Findings Based on the exploratory results compiled. et al. Thus.00  5.00  12.00  4. implies that there is an enormous amount of projects which need to be financed.00  ‐ Agricultural Bank of China IV China Construction Bank IV Agricultural Bank of China Share Price ICBC Share Price China Construction Bank Share Price 4.Figure 4.

Finally, the excessive liquidity of the banking system inhibits competition, so even the programmed full liberalization of the deposit rate might not increase competition in this setting. (Garcia-Herrero, et al, 2006) The fluctuation of non-state-owned banks supports the view that the speculative nature of the Chinese securities markets contributes to the under and over valuation of its listed companies. The research results indicate that the market price is frequently out of line with the estimate intrinsic value; and, second, that there seems to be an inherent tendency for these disparities to correct themselves. It can be assumed that throughout these periods,

investors fall prey to their emotions and as a group may decrease a stock price below intrinsic value during market pessimism. Conversely, stock prices appear to increase to levels above intrinsic value upon market optimism. Non-state-owned banks seem to fluctuate so much that it is uncertain whether any convergence would be statistically significant. State-owned convergence is more likely to be significant. Graham (2003) and Montgomery (2010) assert that in the short run, stock markets are in essence a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion with voting requiring only money, not intelligence or emotional stability. However, they also stress that in the long term the market is a weighing machine and therefore share price performance eventually reflects the economic performance of the underlying business whereby over time, price will reflect the direction of intrinsic value.

57

V.

Research Findings and Conclusions

5.1 Introduction
This section discusses the research findings on valuation range estimated through the use of the Asset Approach, Market Approach and the Montgomery Method. This is followed by discussion of the implication and the limitations of the research. Recommendations for future research are presented and finally this is followed by the conclusion of the paper.

5.2 Considerable Differences Among Various Evaluations
The objective of the study is to examine whether the developing securities markets of China undervalue or overvalue member banks by measuring indicators of profitability and growth such as Return on Equity, illustrating how efficiently bank management allocates capital and thereby allowing an estimate of their intrinsic values in comparison to their listed market prices. In studying the financial data from each bank’s annual reports, the research evaluated the companies according to three methods; a calculated equity per share, a spot price paid for shares by foreign investors and an estimated intrinsic value. For each method, the research further conducted a comparison between the valuation range and year-end market share price. The new valuation method proposed by Roger Montgomery and used by this research indicates a different value investing philosophy with a value estimate significantly different from other valuation methods results indicated within the table series 4.5.1 and 4.5.2. Therefore the research sheds more light on the comparable value of the Chinese banks and shows a more complete picture of these banks in depth.

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It is suggested that one reason for the stability of the state-owned banks in comparison with the non-state-owned banks is the capital inflows from the PRC government. The economic performance of all four state-owned banks was significantly improved due to the creation of four asset managing companies to purchase non-performing assets and remove them from the banks’ balance sheets.

5.3 Research Implications
The results of this research support partially the first hypothesis put forward in chapter II which indicates that there is a large discrepancy between Chinese banks intrinsic values and their listed share prices. However the research does not support the second hypothesis that non-state-owned banks will have an intrinsic value closer to their listed market price when compared with state-owned banks was not upheld. This research contributes to the understanding of Chinese banks as a hot area of emerging economies and transitory economies. As indicated by the comparative case of HSBC, this research also makes its contribution to the evaluation of bank performance in a developed economy.

5.4 Limitations of the Research
While focusing on the developing securities markets of China, most foreign ownership transactions occurred in the Hong Kong Stock Exchange. It is suggested for future research to study the robustness of the valuation methods against a larger sample of the Chinese banks. This research only applies the valuation methods to the banks with a limited time series data. Therefore the results may not be significant enough to indicate any strong trend for these banks. This may explain some of the volatile statistics that were found by the research. Larger sample sizes and longer time periods may lead to a

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it seems the four Chinese stateowned banks have a strong competitive advantage over the non-state-owned banks.more concrete conclusion of whether the valuation ranges are optimal in estimating intrinsic value. 5. Other qualitative factors of value such as brand names. The most valuable competitive advantages are those that allow a company to raise service fees or charges each year. management and so forth have not been evaluated in terms of their affect on intrinsic value.5 Recommendations for Future Research This study utilizes the data available in annual reports in its valuation method. Given the government regulation controlling the banking sector. In order for a fair estimate of intrinsic value. Montgomery (2010) states “a continuous emotional attachment to the brand/product or service” provides that ability. It is recommended that future research test the results against a larger group of comparable companies. aggregated analysts’ predicted future earnings of listed companies could potentially be used to estimate future intrinsic values. Therefore it is suggested to study the effects of 60 . Due to their size and established brand. it is worth noting that the inability of banks (state and nonstate owned) to adjusted their fees independently may have long term effects on their profitability. the Montgomery Method requires a strong competitive advantage of the targeted company in order to maintain stable returns on equity and little or no debt as high levels of borrowing can make return on equity look artificially good. However it does not take into account issues such as convertible bonds and the debt levels of the banks. This research has focused primarily on quantitative factors effecting intrinsic value. However. corporate governance.

such as NPLs which drastically reduced their value. The Montgomery Method can be enhanced by the addition of qualitative factors and measuring the influence of them on intrinsic value. Finally. Montgomery( 2010) posits that over the long term. This has the potential to become an important parameter of corporate growth. an analysis of the price / value differences of dual listed companies between the Hong Kong Stock Exchange and Shanghai Stock Exchange. This research was lucky in its timing as the banks have been through a transitionary aspect of the economy and have begun adapting to the nature of a market economy. 61 . (1988) and Montgomery (2010). specifically the Shanghai Stock Exchange. So a longitudinal study over an extended period could test the correlation between estimated intrinsic value and market share price. As this research only studies the banks listed in China. it is suggested for future works to examine whether the results still hold when conducted in other countries. Five years prior. the Chinese banks had numerous performance problems. 5. a study of applying different levels of the required return to generate a valuation range and a margin of safety as described by Graham et al. there was limited financial data available for estimating the value of the Chinese banks. prices converge with intrinsic value. for example.estimated future intrinsic value in a longitudinal study. a comparison between Shanghai and Hong Kong exchanges could be examined. And in the case of China.6 Conclusions The timing of the research is significant as ten years prior.

sell or hold. societal and technological factors. Conversely. The research also hopes to encourage more studies in Graham-style valuing of firms and utilizing the best methods in valuing companies. to buy. a price that is well above the estimated valuation doesn’t mean the share price is going to fall. Value can change due to various factors such as political. this study contributes an additional method. This comparison can then be used to base an investment decision. It is thus hoped that a more effective methodology is then derived for industry practice in the future. economic. does not mean the price will go up. Therefore it can be concluded that the combined valuation methods and valuation range used in this research provide a much better reference base to compare with price. but value-driven. Investment behavior should not be price-driven. Just because a company’s share price is lower than the estimated valuation. 62 . the Montgomery Method. The idea is not to be perfect but to protect capital and do better than the market. including the valuation methods used.As various valuation methods are practiced by financial analysts in valuing companies.

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50%  50.000  5.625  0.458 1.25%  20.272 2.421  6.750 2.499 2.1 Multiplier Selection when a Company Pays Out 100 percent of its Earnings Company's  Return on  Equity  5.845  5.037  6.708 2.682 0.055 2.000 2.813  3.563  6.666 1.110 5.063  4.893  1.500  2.393  3.226 4.00%  8%  0.222 2.790 4.332 3.541 3.429  1.250 1.857  3.00%  32.665 6.500  Investor's Required Rate of Return After‐Tax  9% 10% 11% 12% 13%  0.563  1.453 4.268  4.772 4.50%  55.188  7.408 3.00%  27.229  6.307  3.389 1.888 3.460  5.143  2.50%  25.833 0.750 4.00%  52.730  2.500 4.00%  42.090 3.322  2.250 2.750 3.250  1.364 1.Appendix Table 2.00%  57.375  4.667 1.438  3.833 0.500 2.444 4.777 2.916 2.721 4.115  3.083 1.291 2.277 4.387 5.000 3.076  4.999 4.499  3.50%  40.374 4.832 5.582 4.577  1.884  4.250  6.286  70 .625 0.333 3.125  3.00%  37.714  0.875  7.964  2.000 1.750 1.166 3.957 3.107  4.999 4.50%  35.863 3.750  4.750 0.607  1.00%  12.455 0.749 3.500 4.154  1.944 1.923  3.538  2.00%  22.875  2.625  5.999 4.500 2.136 1.188  2.071  1.500 3.357  0.818 1.250 1.250 4.500 1.111 1.50%  30.536  0.556 0.692  4.929  4.045 1.00%  17.909 0.786  1.417 0.653  5.124 2.214  3.036  3.25%  10.875 1.00%  47.385  0.544 4.591 1.954 2.554 5.50%  45.636 3.50%  60.042 0.131  5.750  3.000 0.938  6.50%  15.317 3.250 2.000 4.500 0.769  1.688  5.165 3.000 5.181 2.614  14%  0.500 2.750 5.962  1.938  1.610 3.00%  7.679  2.346  2.572  3.500  2.250  1.250 3.727 2.

087 11.521 18.776 8.624  0.00%  7.688  14%  0.867 7.626 13.259 1.029 8.946  6.658 16.00%  47.25%  10.414  14.100 3.50%  25.684  3.840  3.349  2.903 23.729  71 .003 28.50%  45.00%  Investor's Required Rate of Return After‐Tax  8%  0.783 18.717  13.119 19.347 0.50%  60.158 11% 0.180  9.796  11.225 8.50%  50.294  1.126 13.00%  17.796  12.179  0.336  13.119  20.399  24.482 4.207 0.432  7.505  5.050 14.203  5.231  10.50%  40.593  9% 0.899 13.287 0.933 3.469  14.50%  15.467 8.371  3.842 1.932  1.248 15.739  12.050 14.629 21.348 18.344 9.00%  37.119 19.508 3.203 6.917 15.303  11.494 2.302 25.132  18.203  6.806 2.157  0.989 16.209  22.688  27.171  2.972 21.733 9.800  8.508 3.100  4.748 4.626 4.00%  12.972 2.347  10.248  16.796 11.433  9.169 30.00%  32.25%  20.076 1.535 10.203 6.010 6.383 5.50%  55.494 1.00%  42.132  1.546  0.914 26.203 6.192 12% 0.708  2.776  9.429 0.494  1.821  37.016  9.094 10.733 10.325  0.290 7.494  2.493 16.561  32.50%  30.Table 2.524 14.596 1.245  3.263 16.305 5.891  6.233  3.092  5.531  15.086 7.943  4.748 2.177 7.119 19.119 13%  0.554  5.815  1.888  10.411 10% 0.890  1.562  8.00%  27.307 2.075 2.449 5.796 12.738 3.372  0.242 0.143  34.299  12.852  4.900  2.740 10.310 4.664 18.720 1.209 1.00%  57.2 Multiplier Selection when a Company Retains 100 percent of its Earnings Company's  Return on  Equity  5.00%  52.000 1.50%  35.783 21.392 12.617  7.732  7.203  5.502 0.00%  22.526 13.076  29.720 1.511 23.214 11.429  0.209 5.032 9.203 6.

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