China's science and innovation board is on bumpy road towards bright future

Editor's note: Wang Jianhui is the general manager of the research & development department at Capital Securities. The article reflects the author's opinions and not necessarily the views of CGTN. 

It is so fitting that we use the saying "everything is difficult at the beginning" to describe the bumpy start of the Chinese A-share market's Science and Technology Innovation Board of the Shanghai Stock Exchange (SSE), also known as the STAR Market.

Launched in 2019, when Sino-U.S. trade relations had been running into strong headwinds, it had accumulated a surge of about 40 percent on the SSE Science and Technology Innovation Board 50 Index within the first two-and-a-half years, only to see the consecutive downturn by 46 percent thereafter. In contrast, the Shanghai Composite Index recorded a rise of 19 percent and later down by 16 percent.

However, the rollercoaster performance and the tougher business environment amid the unprecedented COVID-19 pandemic impact and economic slowdown seemed not to have deterred the market from growing and the investors from jumping on the bandwagon. The market capitalization of the STAR Market has increased from 560.7 billion yuan ($77.31 billion) at its initiation to 5.17 trillion yuan by the end of May, 2024, and its share in comparison to the entire SSE is up from 1.7 percent to 12.1 percent. Its turnover now accounts for 15.3 percent, up from 5.6 percent of the SSE. As a new equity market, it has shown a strong capacity for fundraising; its initial public offerings and seasoned financings accounted for 40 percent and 11.5 percent of the SSE last year, according to iFind Financial Data (iFind).

In the exchange traded funds (ETF) investment area, which is suitable for both long-term investors and short-term traders, the STAR Market is especially welcomed. 

Although there are currently only five ETFs connected to STAR Market companies, they have reached 95.7 billion shares, accounting for 6.5 percent of the SSE's ETF market.

According to calculations by iFind, the median number of fund holders and average shares held per fund holder are 20,890 and 134,000 shares, compared to the market's average of 3,521 holders and 67,300 shares, respectively. Last year, net subscriptions minus redemptions reached 40.3 billion shares, accounting for 10.1 percent of the market's net subscriptions.

Several reasons could explain the passion for the board. 

Thanks to the stringent and market-oriented institutional design, the new segment has been more inclusive and able to attract excellent companies with various backgrounds and competitive strengths. 

It does not matter whether your firm is a "red chip" (a Chinese company registered abroad and listed on the Hong Kong Stock Exchange), a "variable interest entity" (or VIE, meaning a Chinese company controlled by a foreign-listed entity through a wholly foreign-owned enterprise in China), or a company with differentiated voting rights arrangements, as long as it meets at least one of the five listing standards concerning revenues, net incomes and operational cash flows. 

If your firm's main business requires governmental approvals and has huge market potential, and major technological advancements have been achieved, it is also eligible to be listed.

More importantly, the time needed has been shortened to three to six months, thus the time cost going through the procedures has been greatly reduced for applying companies.  There are currently 1,126 intending companies and candidates preparing for listing in the market on top of the 592 listed ones. And it is much harder for the less qualified or "bad boys" to sneak in; among the 920 registration applications, 328 have been terminated or denied, according to iFind data.

The investors like the segment also because of the outstanding quality of the companies. Most of the companies, or more than 75 percent of the applicants have their headquarters or main operational sites in Jiangsu, Guangdong and Shanghai, the most developed regions in the country, where the business environment is more accommodating. Seventy-one percent of the applying companies concentrate in the computer, software, data, specialized equipment, biotechnology and pharmaceutical industries, or the "national strategic emerging industries" actively encouraged and supported by the government. A total of 78.2 percent of the applicants met the standard category one, meaning that they had reported positive net incomes no less than 50 million yuan in the past two years or positive net income in the previous year and a revenue of 100 million yuan or more; that could be a strong signal of proven technological advancements or business models, and sound operations.  

More promising are the research and development (R&D) input to revenue ratios, which range between 13.8 to 17.7 percent, significantly higher than the median level (4.84 percent) of the total A-share market, based on calculations using iFind data. Higher R&D often leads to technological improvements or even breakthroughs.

To many investors, the STAR Market could be the local alternative to the overseas markets — especially the U.S. market, where the Chinese technology concept stocks used to be eye-catching outperformers. In the past five years, the investment environment has turned less friendly, and the total number of Chinese concept stocks in the U.S. has stagnated at around 280, while the total market capitalization has drastically slumped by 62.6 percent to $865.2 billion. More companies must deal with de-listing or pre-delisting procedures for non-economic reasons. Given these uncertainties, it makes sense to reduce the exposure to the U.S. market and to increase the presence in the local STAR Market, whose average valuation has been down to 30 times the price-to-earnings ratio compared to over 76 times in 2020, based on calculations using iFind data.